Regulating the Financial Cycle: An Integrated Approach with a Leverage Ratio

Economics Letters, 136 (2015), 70-72.

Duisenberg School of Finance - Tinbergen Institute Discussion Paper TI15-057/IV/DSF 93

7 Pages Posted: 19 May 2015 Last revised: 15 Jan 2016

See all articles by Dirk Schoenmaker

Dirk Schoenmaker

Rotterdam School of Management, Erasmus University; Erasmus Research Institute of Management (ERIM); Centre for Economic Policy Research (CEPR)

Peter Wierts

De Nederlandsche Bank; VU University Amsterdam

Date Written: August 13, 2015

Abstract

We propose a regulatory approach for restricting debt financing as an amplification mechanism across the financial system. A small stylised model illustrates the trade-off between static and time varying limits on leverage in dampening the financial cycle. The policy section proposes its application to highly leveraged entities and activities across the financial system. Whereas the traditional view on regulation focuses on capital as a buffer against exogenous risks, our approach focuses instead on debt financing, endogenous feedback mechanisms and resource allocation. It explicitly addresses the boundary problem in entity-based financial regulation and provides a motivation for substantially lower levels of leverage – and thereby higher capital buffers – than in the traditional approach.

Keywords: Financial cycle, macroprudential regulation, financial supervision, (shadow) banking.

JEL Classification: E58, G10, G18, G20, G58.

Suggested Citation

Schoenmaker, Dirk and Wierts, Peter, Regulating the Financial Cycle: An Integrated Approach with a Leverage Ratio (August 13, 2015). Economics Letters, 136 (2015), 70-72.; Duisenberg School of Finance - Tinbergen Institute Discussion Paper TI15-057/IV/DSF 93. Available at SSRN: https://ssrn.com/abstract=2607619

Dirk Schoenmaker (Contact Author)

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam
Netherlands

HOME PAGE: http://www.rsm.nl/people/dirk-schoenmaker/

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Peter Wierts

De Nederlandsche Bank ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

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