Differential Capital Requirements: Leverage Ratio versus Risk-Based Capital Ratio from a Monitoring Perspective

32 Pages Posted: 5 Oct 2014

See all articles by Lakshmi Balasubramanyan

Lakshmi Balasubramanyan

Case Western Reserve University - Weatherhead School of Management

Date Written: October 2, 2014

Abstract

In this paper, I attempt to amalgamate the study of leverage-ratio performance with the monitoring decisions of a profit-maximizing bank. Applying tools used in studying the industrial organization of banking, my paper serves as a first step to tying the performance differences between the leverage and risk-based constraints to the more fundamental issue of monitoring. Does a bank faced with a leverage-based capital constraint monitor its loans better than a bank under a risk-based capital constraint? In a market that is characterized by a dominant bank and fringe banks, I seek to understand if the dominant bank monitors its loan when faced with a Basel III-style leverage ratio. The results show that under certain parameter ranges, the dominant bank will monitor its portfolio when faced with a leverage-based capital constraint. The results also show that the dominant bank will not monitor its portfolio when faced with a risk-based capital constraint.

Keywords: Differential capital requirements, dominant-bank model, bank loan

JEL Classification: G20

Suggested Citation

Balasubramanyan, Lakshmi, Differential Capital Requirements: Leverage Ratio versus Risk-Based Capital Ratio from a Monitoring Perspective (October 2, 2014). FRB of Cleveland Working Paper No. 14-15. Available at SSRN: https://ssrn.com/abstract=2505148 or http://dx.doi.org/10.2139/ssrn.2505148

Lakshmi Balasubramanyan (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

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