How Banks Exploit Reporting Rules to Cover Up Their Leverage Risk

49 Pages Posted: 4 Apr 2019 Last revised: 6 Dec 2019

See all articles by Florian Balke

Florian Balke

Goethe University Frankfurt - Department of Finance

Date Written: March 14, 2019

Abstract

I provide empirical evidence of how banks conceal their actual leverage risk on reporting days at the end of the quarter following the introduction of the leverage ratio (LR) public disclosure. Using a novel dataset of wholesale deposit transactions, I show that the intended backstop function of the LR to prevent the excessive build-up of leverage risk is generally effective. However, EU Banks, which follow a reference day calculation approach of the LR, that are relatively more constrained by the LR requirement than the risk-based capital requirement and are also close to the minimum LR requirement significantly contract their balance sheets by reducing short-term wholesale deposits at quarter-ends. They repay wholesale liabilities by reducing their loan holdings. At the same time, such banks increase the risk of the loan portfolio by originating higher-yielding loans.

Keywords: leverage ratio, capital requirements, window dressing, bank regulation, wholesale funding

JEL Classification: G21, G28

Suggested Citation

Balke, Florian, How Banks Exploit Reporting Rules to Cover Up Their Leverage Risk (March 14, 2019). Available at SSRN: https://ssrn.com/abstract=3352820 or http://dx.doi.org/10.2139/ssrn.3352820

Florian Balke (Contact Author)

Goethe University Frankfurt - Department of Finance ( email )

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

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