Basel III Leverage Ratio Requirement and the Probability of Bank Runs

40 Pages Posted: 8 Jan 2015

Date Written: January 7, 2015

Abstract

A new argument for the Basel III leverage ratio requirement is proposed: the need to limit the risk of a bank run when there is imperfect information on the value of a bank’s assets. In addition to screening and monitoring borrowers, banks provide liquidity insurance with the supply of short-term deposits withdrawable on demand. The maturity mismatch creates the risk of a disorderly bank run which can be exacerbated by imperfect information about the value of bank assets. It is shown in a stylized Basel III framework that capital regulation should incorporate a liquidity risk component. Credit risk diversification and/or a reduced probability of loan default which lead to a reduction of Basel III regulatory capital will increase the probability of a bank run. The leverage ratio rule puts a floor on the Basel III risk-weighed capital ratio, allowing the limitation of such a risk.

Suggested Citation

Dermine, Jean, Basel III Leverage Ratio Requirement and the Probability of Bank Runs (January 7, 2015). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2546239

Jean Dermine (Contact Author)

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 60 72 41 33 (Phone)

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