Leverage Ratio, Risk-Based Capital Requirements, and Risk-taking in the UK

Mahmoud Fatouh, Simone Giansante and Steven Ongena
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Mahmoud Fatouh: Bank of England and University of Essex
Simone Giansante: University of Palermo

No 23-91, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

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 re-optimise, 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 5-year subordinated debt of LR banks fell relative to non-LR banks post leverage ratio introduction.

Keywords: 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: 31 pages
Date: 2023-10
New Economics Papers: this item is included in nep-ban, nep-cba, nep-eec and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2391

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