Changes in bank leverage: evidence from US bank holding companies

This paper examines how banks respond to shocks to their equity. If banks react to
equity shocks by more than proportionately adjusting liabilities, then this will tend to
generate a positive correlation between asset growth and leverage growth. However, we
show that in the presence of changes in liabilities that are uncorrelated with shocks to
equity, a positive correlation of this sort can occur without banks adjusting to equity
shocks by more than proportionately adjusting liabilities. The paper uses data from
US bank holding companies to estimate an empirical model of bank balance sheet
adjustment. We identify shocks to equity as well as orthogonal shocks to bank liabilities
and show that both equity and liabilities tend to adjust to move leverage towards target
ratios. We also show that banks allow leverage ratios to fall in response to positive
equity shocks, though this pattern is weaker for large banks, which are more active
in adjusting liabilities after these shocks. We show how this explains why large banks
have lower correlations between asset growth and leverage growth.