Summary of Business Models of Banks, Leverage and the Distance-to-Default

In: OECD Journal: Financial Market Trends

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Business Models of Banks, Leverage and the Distance-to-Default  summary
Can a bank’s business model and leverage predict its demise?

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Economists Adrian Blundell-Wignall and Caroline Roulet are among the first to conduct research on the business and financial variables that indicate how near a bank might be to defaulting. Their study covers 94 internationally active financial institutions from 2004 to 2011, including the world’s biggest commercial and investment banks during the 2008 crisis. Their econometric modeling provides hard data to support what many observers intuitively grasped but could not prove: Highly leveraged financial institutions active in derivatives and reliant on market funding are inherently more risky than less-leveraged deposit-funded banks with less exposure to derivatives. getAbstract suggests their scholarly study to financial policy makers, regulators and bankers.

In this summary, you will learn

  • How econometric modeling can determine banks’ “distance-to-default,”
  • What factors affect a bank’s risk of default over time
  • What recommendations emerge from the research’s findings
 

Summary

Since the onset of the 2008 financial crisis, the Organisation for Economic Co-operation and Development (OECD) has held that overly indebted banks operating extensively in highly leveraged derivatives and structured instruments markets are more prone to collapse. If interbank credit markets seize, ...
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About the Authors

Adrian Blundell-Wignall is the special adviser to the Organisation for Economic Co-operation and Development (OECD) secretary general on financial markets, and Caroline Roulet is an OECD economist.


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