Regulating bank leverage

Alexander Bleck

Journal of Financial Economic Policy, 2018, vol. 10, issue 2, 264-274

Abstract: Purpose - This paper aims to study the design of bank capital regulation and points out a conceptual downside of risk-sensitive regulation. The author argues that when a bank is better informed about its risk than the regulator, designing regulation is subject to the Lucas critique. The second-best regulation could be risk-insensitive, which provides an explanation for the leverage ratio as a backstop to risk-based capital requirements. This paper offers empirical predictions and implications for policy. Design/methodology/approach - The argument in the paper is based on analytical results from mechanism design. Findings - Optimal bank regulation could be risk-insensitive, as is observed in practice in the form of the leverage ratio rule. Originality/value - Counter to conventional wisdom, the paper argues and provides a new explanation for why bank regulation should not be sensitive to the risk of the bank. The paper then offers empirical predictions and implications for policy.

Keywords: Banks; Systemic risk; Financial markets and institutions; Financial risk and risk management; Regulation and industrial policy; Allocative efficiency; Macroprudential regulation; Leverage ratio; D61; D62; D82; G21; G28 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-12-2017-0122

DOI: 10.1108/JFEP-12-2017-0122

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