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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

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    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. Blair,Roger D. & Harrison,Jeffrey L., 2010. "Monopsony in Law and Economics," Cambridge Books, Cambridge University Press, number 9780521746083.
    4. Blair,Roger D. & Harrison,Jeffrey L., 2010. "Monopsony in Law and Economics," Cambridge Books, Cambridge University Press, number 9780521762304.
    5. Mariathasan, Mike & Merrouche, Ouarda, 2014. "The manipulation of basel risk-weights," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 300-321.
    6. 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.
    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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