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Differential Capital Requirements: Leverage Ratio versus Risk-Based Capital Ratio from a Monitoring Perspective

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  • Lakshmi Balasubramanyan

Abstract

In this paper, I attempt to amalgamate the study of leverage-ratio performance with the monitoring decisions of a profit-maximizing bank. Applying tools used in studying the industrial organization of banking, my paper serves as a first step to tying the performance differences between the leverage and risk-based constraints to the more fundamental issue of monitoring. Does a bank faced with a leveragebased capital constraint monitor its loans better than a bank under a risk-based capital constraint? In a market that is characterized by a dominant bank and fringe banks, I seek to understand if the dominant bank monitors its loan when faced with a Basel III?style leverage ratio. The results show that under certain parameter ranges, the dominant bank will monitor its portfolio when faced with a leverage-based capital constraint. The results also show that the dominant bank will not monitor its portfolio when faced with a risk-based capital constraint.

Suggested Citation

  • Lakshmi Balasubramanyan, 2014. "Differential Capital Requirements: Leverage Ratio versus Risk-Based Capital Ratio from a Monitoring Perspective," Working Papers (Old Series) 1415, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:1415
    DOI: 10.26509/frbc-wp-201415
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    References listed on IDEAS

    as
    1. Blum, Jürg M., 2008. "Why 'Basel II' may need a leverage ratio restriction," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1699-1707, August.
    2. Asli Demirguc-Kunt & Enrica Detragiache & Ouarda Merrouche, 2013. "Bank Capital: Lessons from the Financial Crisis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(6), pages 1147-1164, September.
    3. Arturo Estrella & Sangkyun Park & Stavros Peristiani, 2000. "Capital ratios as predictors of bank failure," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 33-52.
    4. Blair,Roger D. & Harrison,Jeffrey L., 2010. "Monopsony in Law and Economics," Cambridge Books, Cambridge University Press, number 9780521746083, November.
    5. Mariathasan, Mike & Merrouche, Ouarda, 2014. "The manipulation of basel risk-weights," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 300-321.
    6. Blair,Roger D. & Harrison,Jeffrey L., 2010. "Monopsony in Law and Economics," Cambridge Books, Cambridge University Press, number 9780521762304, November.
    7. VanHoose, David D, 1985. "Bank Market Structure and Monetary Control," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(3), pages 298-311, August.
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    More about this item

    Keywords

    Differential capital requirements; dominant-bank model; bank loan monitoring;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services

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