Capital Regulation with Heterogeneous Banks - Unintended Consequences of a Too Strict Leverage Ratio

Gutenberg School of Management and Economics Discussion Paper No. 1310

40 Pages Posted: 28 Jan 2014 Last revised: 22 Dec 2015

See all articles by Andreas Barth

Andreas Barth

Goethe University Frankfurt - Department of Finance

Christian Seckinger

Johannes Gutenberg University Mainz - Gutenberg School of Economics and Management; Goethe University Frankfurt - Graduate School of Economics, Finance and Management (GSEFM)

Date Written: December 22, 2015

Abstract

We provide a general 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: Banks are not allowed to absorb the entire supply of debt if they cannot raise new equity, which induces agents with a lower monitoring skill to open a bank. This decreases the average ability of operating banks. We further show that rising heterogeneity in the banking sector increases this negative effect and that additional instruments of the regulator and additional outside options of agents cannot overcome this unintended allocation effect.

Keywords: leverage ratio, bank regulation, risk-taking, financial stability.

JEL Classification: G21, G28

Suggested Citation

Barth, Andreas and Seckinger, Christian, Capital Regulation with Heterogeneous Banks - Unintended Consequences of a Too Strict Leverage Ratio (December 22, 2015). Gutenberg School of Management and Economics Discussion Paper No. 1310, Available at SSRN: https://ssrn.com/abstract=2374332 or http://dx.doi.org/10.2139/ssrn.2374332

Andreas Barth (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt, 60629
Germany

Christian Seckinger

Johannes Gutenberg University Mainz - Gutenberg School of Economics and Management ( email )

Mainz
Germany

Goethe University Frankfurt - Graduate School of Economics, Finance and Management (GSEFM) ( email )

House of Finance
Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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