Journal of Financial Stability Vol. 74 2024
The leverage ratio, risk-taking and bank stability
Abstract
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.
- DOI
- 10.1016/j.jfs.2020.100833
- Volume
- 74
- Pages
- 100833
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref