The leverage ratio, risk-taking and bank stability

The leverage ratio, risk-taking and bank stability

This paper analyses the trade-off between additional loss-absorbing capacity and potentially higher bank risk-taking associated with the introduction of the Basel III Leverage Ratio. This is addressed in both a theoretical and empirical setting. Using a theoretical micro model, we show that a levera...

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Bibliographic Details
Published in:Journal of financial stability Vol. 74; p. 100833
Main Authors: Acosta-Smith, Jonathan, Grill, Michael, Lang, Jan Hannes
Format: Journal Article
Language:English
Published: Elsevier B.V 01-10-2024
Subjects:
Banking
Capital regulation
Leverage ratio
Risk-taking
Capital regulation
Leverage ratio
G21
Banking
G01
G28
Risk-taking
Online Access:Get full text
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Summary:This paper analyses the trade-off between additional loss-absorbing capacity and potentially higher bank risk-taking associated with the introduction of the Basel III Leverage Ratio. This is addressed in both a theoretical and empirical setting. Using a theoretical micro model, we show that a leverage ratio requirement can incentivise banks that are bound by it to increase their risk-taking. This increase in risk-taking however, should be outweighed by the benefits of higher capital, thereby leading to more stable banks. These theoretical predictions are tested and confirmed in an empirical analysis on a large sample of EU banks. Our baseline empirical model suggests that a leverage ratio requirement leads to a significant decline in the distress probability of highly leveraged banks.
ISSN:1572-3089
DOI:10.1016/j.jfs.2020.100833