Bank Leverage Ratios and Financial Stability: A Micro- and Macroprudential Perspective

Emilios Avgouleas

Economics Working Paper Archive from Levy Economics Institute

Abstract: Bank leverage ratios have made an impressive and largely unopposed return; they are mostly used alongside risk-weighted capital requirements. The reasons for this return are manifold, and they are not limited to the fact that bank equity levels in the wake of the global financial crisis (GFC) were exceptionally thin, necessitating a string of costly bailouts. A number of other factors have been equally important; these include, among others, the world's revulsion with debt following the GFC and the eurozone crisis, and the universal acceptance of Hyman Minsky's insights into the nature of the financial system and its role in the real economy. The best examples of the causal link between excessive debt, asset bubbles, and financial instability are the Spanish and Irish banking crises, which resulted from nothing more sophisticated than straightforward real estate loans. Bank leverage ratios are primarily seen as a microprudential measure that intends to increase bank resilience. Yet in today's environment of excessive liquidity due to very low interest rates and quantitative easing, bank leverage ratios should also be viewed as a key part of the macroprudential framework. In this context, this paper discusses the role of leverage ratios as both microprudential and macroprudential measures. As such, it explains the role of the leverage cycle in causing financial instability and sheds light on the impact of leverage restraints on good bank governance and allocative efficiency.

Keywords: Leverage; Banks; Financial Instability; Macroprudential Regulation; Leverage Cycle; Bubbles; Debt Overhang (search for similar items in EconPapers)
JEL-codes: G21 G28 K22 (search for similar items in EconPapers)
Date: 2015-10
New Economics Papers: this item is included in nep-ban and nep-pke
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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