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The leverage ratio, risk-taking and bank stability

Jonathan Acosta Smith, Michael Grill and Jan Hannes Lang

No 2079, Working Paper Series from European Central Bank

Abstract: This paper addresses the tradeoff 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 more than outweighed by the benefits of higher capital and therefore increased lossabsorbing capacity, 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 would lead to a significant decline in the distress probability of highly leveraged banks. JEL Classification: G01, G21, G28

Keywords: bank capital; Basel III; leverage ratio; risk-taking (search for similar items in EconPapers)
Date: 2017-06
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
Note: 1280809
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Working Paper: The leverage ratio, risk-taking and bank stability (2018) Downloads
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