Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/212189 
Year of Publication: 
2011
Series/Report no.: 
Bank of Finland Research Discussion Papers No. 10/2011
Publisher: 
Bank of Finland, Helsinki
Abstract: 
We study the effects on credit allocation and bank stability of introducing a leverage ratio requirement (LRR) on top of risk-based capital requirements, as in Basel III. For the current 3% LRR, both low-risk and high-risk loan rates and volumes remain essentially unchanged, because banks previously specializing in low-risk lending can adapt by granting both low-risk and high-risk loans. For sufficiently high LRRs, low-risk lending rates would significantly increase and high-risk lending rates would fall. In the presence of severe model risk concerning low-risk loans, as happened in the subprime crisis, the current 3% LRR might even reduce bank stability, counter to regulatory intentions. This is because the allocational effect caused by the LRR, which makes bank loan portfolios more alike, may turn beneficial risk spreading into harmful risk contamination. For higher levels of LRR, however, bank stability is likely to be improved even in the presence of model risk.
Subjects: 
bank regulation
Basel III
capital requirements
credit risk
leverage ratio
JEL: 
D41
D82
G14
G21
G28
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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