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Capital regulation with heterogeneous banks – Unintended consequences of a too strict leverage ratio

Andreas Barth and Christian Seckinger

Journal of Banking & Finance, 2018, vol. 88, issue C, 455-465

Abstract: We provide an equilibrium analysis of potential consequences from the introduction of a binding leverage ratio, as proposed in Basel III. If banks differ in their monitoring skills and their ability to successfully complete a risky investment project, a tighter leverage ratio does not only mitigate moral hazard arising from limited liability, but also carries an unintended consequence: high-quality banks are not allowed to absorb the entire supply of debt if it is too costly to issue new equity. This increases the market share of low-skilled bankers and decreases the average ability of operating banks. We further show that rising heterogeneity in the banking sector increases this negative effect.

Keywords: Leverage ratio; Bank regulation; Risk-taking; Financial stability (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:jbfina:v:88:y:2018:i:c:p:455-465