The Basel III Leverage Ratio: Unaffected by the Applied Risk Measurement Approach?

Abstract

We examine the effects of the recently introduced regulatory leverage ratio, which aims to backstop existing risk-weighted capital requirements, on banks' balance sheets. We observe on average a deleveraging process, while banks simultaneously increase their risk-weighted assets. Having less regulatory leeway, banks applying the standardized approach are more inclined to raise capital in order to adjust the leverage ratio upwards. This implies that such banks become more stable as intended by policy makers. In contrast, the need to raise capital is significantly less pronounced for banks using internal models, which face more adjustment leeway when increasing their leverage ratio. Our findings suggest that imposing an unweighted leverage restriction does not necessarily alleviate the benefits from minimizing risk-weighted assets.

Keywords: Basel III leverage ratio, internal ratings-based approach, dynamic capital structure, balance sheet adjustment

JEL Classification: G21, G28, G32