Financial leverage of commercial banks: the case of Baltic countries

Abstract

The crisis events started in 2007 missed no country and revealed those risks and problems which had not been paid due attention before the crisis. One of such underestimated risks is the risk of commercial banks’ financial leverage impact upon economic development. Financial leverage is the ratio of the bank’s assets towards its capital. Increase in financial leverage allows the bank reaching higher returns on capital. High level of banks financial leverage, in turn, contributes to occurrence of crisis events. Thus, uncontrollable credit expansion on growing market leads to increasing profits while adverse cycle phases multiply losses and deepens economic recession. Why? What is the mechanism of banks financial leverage impact upon economy? How to restrict negative effect of this impact by managing the financial leverage? Author of this article tries answering these questions. The purpose of this study is to assess changes in financial leverage level in banks of Baltic countries, clarify mechanisms of banks financial leverage impact upon stability of the banks themselves and upon economy in general, as well as develop recommendations for financial leverage management in order to smoothen adverse economic changes.