The leverage ratio, risk-taking and bank stability

Jonathan Acosta-Smith, Michael Grill and Jan Hannes Lang

Journal of Financial Stability, 2024, vol. 74, issue C

Abstract: 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.

Keywords: Banking; Capital regulation; Risk-taking; Leverage ratio (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:74:y:2024:i:c:s1572308920301364

DOI: 10.1016/j.jfs.2020.100833

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