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Regulating bank leverage

Author

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  • Alexander Bleck

Abstract

Purpose - This paper aims to study the design of bank capital regulation and points out a conceptual downside of risk-sensitive regulation. The author argues that when a bank is better informed about its risk than the regulator, designing regulation is subject to the Lucas critique. The second-best regulation could be risk-insensitive, which provides an explanation for the leverage ratio as a backstop to risk-based capital requirements. This paper offers empirical predictions and implications for policy. Design/methodology/approach - The argument in the paper is based on analytical results from mechanism design. Findings - Optimal bank regulation could be risk-insensitive, as is observed in practice in the form of the leverage ratio rule. Originality/value - Counter to conventional wisdom, the paper argues and provides a new explanation for why bank regulation should not be sensitive to the risk of the bank. The paper then offers empirical predictions and implications for policy.

Suggested Citation

  • Alexander Bleck, 2018. "Regulating bank leverage," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 10(2), pages 264-274, July.
    • Handle: RePEc:eme:jfeppp:jfep-12-2017-0122
    DOI: 10.1108/JFEP-12-2017-0122
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    Citations

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    Cited by:

    1. Ozili, Peterson K, 2019. "Non-performing loans in European systemic and non-systemic banks," MPRA Paper 94008, University Library of Munich, Germany.

    More about this item

    Keywords

    Banks; Systemic risk; Financial markets and institutions; Financial risk and risk management; Regulation and industrial policy; Allocative efficiency; Macroprudential regulation; Leverage ratio; D61; D62; D82; G21; G28;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • 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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