Banks Adjust Slowly: Evidence and Lessons for Modeling

This paper presents five facts on the behavior of U.S. banks between 2007 and 2015 that impose useful restrictions on the formulation of a bank problem. (1) Market to book leverage ratio diverged significantly during the crisis. (2) Book values appear to be backward looking. There is more information content about future bank profitability and loan losses in market values than in book values. (3) Neither market nor regulatory constraints are strictly binding for most banks. (4) Banks operate with a target market leverage ratio. (5) The adjustment behavior back to the target changed fundamentally after the crisis. We present a heterogeneous-bank model that rationalizes these facts and can serve as a building block for future work.