This paper investigates both the magnitude and the drivers of bank window dressing behavior in euro-denominated repo markets. Using a confidential transaction-level data set, our analysis illustrates that banks engineer an economically sizeable contraction in their repo transactions around regulatory reporting dates. We establish a causal link between these reductions and banks’ incentives to window dress and document the role of the leverage ratio and the G-SIB framework as the most relevant drivers of window dressing behavior. Our findings suggest that regulatory action is warranted to limit banks’ ability to window dress.

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.