Bank Leverage and Capital Bias Adjustment Through the Macroeconomic Cycle
Journal of Risk, 2020
58 Pages Posted: 11 Sep 2020
Date Written: February 2, 2020
We assess the quantitative effects of the recent proposal for more robust bank capital adequacy (Admati and Hellwig, 2013; Myerson, 2014). Our theoretical proof and evidence accord with the core thesis that banks become more stable by increasing its equity capital cushion to absorb extreme losses in times of severe financial stress. This analysis contributes to the ongoing policy debate on total capital adequacy. Our Monte Carlo simulation helps develop an analytical solution for the default probability adjustment through the macroeconomic cycle. This study poses a conceptual challenge to the normative view that banks should maintain high leverage over time.
Keywords: Bank Leverage, Capital, Macroeconomic Default Adjustment, Monte Carlo Simulation, Macro-Prudential Stress Test, Loan Portfolio Segmentation, Logit Default Likelihood Analysis
JEL Classification: G21, G28, G32, G38
Suggested Citation: Suggested Citation