The leverage ratio, risk-taking and bank stability

Jonathan Acosta-Smith (), Michael Grill () and Jan Hannes Lang
Additional contact information
Jonathan Acosta-Smith: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Michael Grill: European Central Bank

No 766, Bank of England working papers from Bank of England

Abstract: This paper addresses 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 more than 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 would lead to a significant decline in the distress probability of highly leveraged banks.

Keywords: Bank capital; risk-taking; leverage ratio; Basel III (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Pages: 74 pages
Date: 2018-09-14
New Economics Papers: this item is included in nep-ban, nep-cba and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: The leverage ratio, risk-taking and bank stability (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0766

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