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Financial Market - 2023 - Fatouh - Leverage ratio risk‐based capital requirements and risk‐taking in the United Kingdom.pdf (1.18 MB)

Leverage ratio, risk-based capital requirements, and risk-taking in the United Kingdom

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journal contribution
posted on 2023-12-21, 09:50 authored by M Fatouh, S Giansante, S Ongena
We assess the impact of the leverage ratio capital requirements on the risk-taking behaviour of banks both theoretically and empirically. Conceptually, introducing binding leverage ratio requirements into a regulatory framework with risk-based capital requirements induces banks to re-optimise, shifting from safer to riskier assets (higher asset risk). Yet, this shift would not be one-for-one due to risk weight differences, meaning the shift would be associated with a lower level of leverage (lower insolvency risk). The interaction of these two changes determines the impact on the aggregate level of risk. Empirically, we use a difference-in-differences setup to compare the behaviour of UK banks subject to the leverage ratio requirements (LR banks) to otherwise similar banks (non-LR banks). Our results show that LR banks did not increase asset risk, and slightly reduced leverage levels, compared to the control group after the introduction of leverage ratio in the UK. As expected, these two changes led to a lower aggregate level of risk. Emperical results indicate that credit default swap spreads on the 5-year subordinated debt of LR banks decreased relative to non-LR banks post leverage ratio introduction, suggesting the market viewed LR banks as less risky, especially during the COVID 19 stress.

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Citation

Fatouh, M., Giansante, S., & Ongena, S. (2023). Leverage ratio, risk-based capital requirements, and risk-taking in the united kingdom. Financial Markets, Institutions & Instruments, 00, 1–30.

Author affiliation

School of Business, University of Leicester

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  • VoR (Version of Record)

Published in

Financial Markets, Institutions and Instruments

Publisher

Wiley

issn

0963-8008

eissn

1468-0416

Copyright date

2023

Available date

2023-12-21

Language

en

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