Risk-Based Capital and Leverage Ratios Adjustments by Banks: Experience from Canada and the U.S.

58 Pages Posted: 28 Sep 2021 Last revised: 5 Nov 2021

See all articles by Hélyoth Hessou

Hélyoth Hessou

Université de Sherbrooke; Université de Sherbrooke

Van Son Lai

Université Laval

Date Written: September 24, 2021

Abstract

The Basel III framework comes with the requirement of a minimum leverage ratio as a backstop to the existing Basel II risk-based capital ratio. Given that Canada and the US have adopted similar double capital rules prior to Basel III, we study the implications of these two rules on bank capital adjustments. We show that the mix of the two-capital rules can be viewed as a “hockey stick” shape single leverage ratio akin to a call option on the bank asset risk, measured by the risk-weighted assets (RWA) -to- total assets ratio, known as the RWA density. The exercise price of this call option is the quotient of the required minimum leverage ratio and the minimum risk-based capital ratio. Since a tighter limit was imposed in Canada than in the US on the "combined" leverage ratio, Canadian banks has exhibited asset risk-sensitive leverage ratios well before the 2007 global financial crisis (GFC). Meanwhile, the loosening regulatory limit on the US bank leverage ratio has rendered the leverage ratio in the US irresponsive or inversely related to US banks’ asset risk.

Keywords: Capital ratio, leverage ratio, Basel Accords, regulation, Canadian banks, US banks

JEL Classification: G21, G28

Suggested Citation

Hessou, Hélyoth and Hessou, Hélyoth and Lai, Van Son, Risk-Based Capital and Leverage Ratios Adjustments by Banks: Experience from Canada and the U.S. (September 24, 2021). Available at SSRN: https://ssrn.com/abstract=3930101 or http://dx.doi.org/10.2139/ssrn.3930101

Hélyoth Hessou

Université de Sherbrooke ( email )

Sherbrooke, Québec J1K 2R1
Canada
J1K 2R1 (Fax)

Université de Sherbrooke ( email )

2500, boulevard de l'Université, Ecole
de gestion, Campus principal (Pav K1)
Sherbrooke, Québec J1K 2R1
Canada
J1K 2R1 (Fax)

Van Son Lai (Contact Author)

Université Laval ( email )

FSA ULaval
Quebec G1V 0A6
Canada
418-656-2131, x3943 (Phone)

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