Leverage ratio and risk-taking: theory and practice

Mahmoud Fatouh (), Simone Giansante and Steven Ongena
Additional contact information
Mahmoud Fatouh: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Simone Giansante: Department of Economics, Business and Statistics, University of Palermo

No 1048, Bank of England working papers from Bank of England

Abstract: We assess the impact of the leverage ratio capital requirements on the risk‑taking behaviour of banks both theoretically and empirically. We use a difference‑in‑differences (DiD) setup to compare the behaviour of UK banks subject to the leverage ratio requirements (LR banks) to otherwise similar banks (non‑LR banks). Conceptually, introducing binding leverage ratio requirements into a regulatory framework with risk-based capital requirements induces banks to reoptimise, shifting from safer to riskier assets (higher asset risk). Yet, this shift would not be one‑for‑one due to risk‑weight differences, meaning the shift would be associated with a lower level of leverage (lower insolvency risk). The interaction of these two changes determines the impact on the aggregate level of risk. Empirically, we show that LR banks did not increase asset risk, and slightly reduced leverage levels, compared to the control group after the introduction of leverage ratio in the UK. As expected, these two changes lead to a lower aggregate level of risk. Our results show that credit default swap spreads on the five‑year subordinated debt of LR banks dropped relative to non‑LR banks post leverage ratio introduction.

Keywords: Finance; capital regulation; risk-taking; leverage ratio; risk‑based requirements (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2023-10-01
New Economics Papers: this item is included in nep-cba, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.bankofengland.co.uk/-/media/boe/files/ ... ory-and-practice.pdf Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:1048

Access Statistics for this paper

More papers in Bank of England working papers from Bank of England Bank of England, Threadneedle Street, London, EC2R 8AH. Contact information at EDIRC.
Bibliographic data for series maintained by Digital Media Team ().