Judging Banks’ Risk by the Profits They Report

In competitive capital markets, risky debt claims that offer high yields in good times have high systematic risk exposure in bad times. We apply this idea to bank risk measurement. We find that banks with high accounting return on equity (ROE) prior to a crisis have higher systematic tail risk exposure during the crisis. Proximate causes of crises differ, but the predictive power of ROE is pervasive, including during the financial crisis of 2007–2010 and the recent crisis triggered by the collapse of Silicon Valley Bank. ROE predicts systematic tail risk much better than conventional measures based on risk-weighted assets.

JEL Classification: G20,G30

Suggested Citation: Suggested Citation

Meiselman, Ben S. and Nagel, Stefan and Purnanandam, Amiyatosh, Judging Banks’ Risk by the Profits They Report (September 5, 2023). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2023-115, Available at SSRN: https://ssrn.com/abstract=4562578 or http://dx.doi.org/10.2139/ssrn.4562578

Ben S. Meiselman

U.S. Department of the Treasury ( email )

1500 Pennsylvania Avenue
Washington, DC 20220
United States

Stefan Nagel (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research ( email )

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Amiyatosh Purnanandam

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States