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Basel III leverage ratio requirement and the probability of bank runs

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  • Dermine, Jean

Abstract

A new argument for the Basel III leverage ratio requirement is proposed: the need to limit the risk of a bank run when there is imperfect information on the value of a bank’s assets. In addition to screening and monitoring borrowers, banks provide liquidity insurance with the supply of short-term deposits withdrawable on demand. The maturity mismatch creates the risk of a disorderly bank run which can be exacerbated by imperfect information about the value of bank assets. It is shown in a stylized Basel III framework that capital regulation should incorporate a liquidity risk component. Credit risk diversification and/or a reduced probability of loan default which lead to a reduction of Basel III regulatory capital will increase the probability of a bank run. The leverage ratio rule puts a floor on the Basel III risk-weighted capital ratio, allowing the limitation of such a risk.

Suggested Citation

  • Dermine, Jean, 2015. "Basel III leverage ratio requirement and the probability of bank runs," Journal of Banking & Finance, Elsevier, vol. 53(C), pages 266-277.
    • Handle: RePEc:eee:jbfina:v:53:y:2015:i:c:p:266-277
    DOI: 10.1016/j.jbankfin.2014.12.007
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    More about this item

    Keywords

    Bank regulation; Basel capital; Leverage ratio; Credit risk;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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