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Do higher capital standards always reduce bank risk? The impact of the Basel leverage ratio on the U.S. triparty repo market

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  • Allahrakha, Meraj
  • Cetina, Jill
  • Munyan, Benjamin

Abstract

While simpler than risk-based capital requirements, the leverage ratio may encourage bank risk-taking. This paper examines the activity of broker-dealers affiliated with bank holding companies (BHCs) and broker-dealers not affiliated with BHCs in the repurchase agreement (repo) market to test whether this may be occurring. Using data on the triparty repo market, the paper arrives at three findings. First, following the 2012 introduction of the supplementary leverage ratio (SLR), broker-dealer affiliates of BHCs decreased their repo borrowing but increased their use of repo backed by more price-volatile collateral. Second, the paper finds that regardless of whether a U.S. BHC-affiliated broker-dealer parent is above or below the SLR requirement, the announcement of the SLR rule has disincentivized those dealers affiliated with BHCs from borrowing in triparty repo. Finally, the paper finds an increase in the number of active nonbank-affiliated dealers in certain asset classes of triparty repo since the 2012 introduction of the supplementary leverage ratio. This illustrates how regulation can have competitive effects on the financial sector and may result in activities shifting among financial firms.

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  • Allahrakha, Meraj & Cetina, Jill & Munyan, Benjamin, 2018. "Do higher capital standards always reduce bank risk? The impact of the Basel leverage ratio on the U.S. triparty repo market," Journal of Financial Intermediation, Elsevier, vol. 34(C), pages 3-16.
  • Handle: RePEc:eee:jfinin:v:34:y:2018:i:c:p:3-16
    DOI: 10.1016/j.jfi.2018.01.008
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    Cited by:

    1. Bank for International Settlements, 2017. "Repo market functioning," CGFS Papers, Bank for International Settlements, number 59, Autumn.
    2. Noss, Joseph & Patel, Rupal, 2019. "Decomposing changes in the functioning of the sterling repo market," Bank of England working papers 797, Bank of England.
    3. Dong Beom Choi & Michael R. Holcomb & Donald P. Morgan, 2020. "Bank Leverage Limits and Regulatory Arbitrage: Old Question‐New Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(S1), pages 241-266, October.
    4. Douglas da Rosa München & Herbert Kimura, 2020. "Regulatory Banking Leverage: what do you know?," Working Papers Series 540, Central Bank of Brazil, Research Department.
    5. Aref Ardekani, 2020. "Liquidity, Interbank Network Topology and Bank Capital," Post-Print halshs-02967226, HAL.
    6. Van Horen, Neeltje & Kotidis, Antonis, 2018. "Repo market functioning: the role of capital regulation," Bank of England working papers 746, Bank of England.
    7. Richard K. Crump & Joao A. C. Santos, 2018. "Review of New York Fed studies on the effects of post-crisis banking reforms," Economic Policy Review, Federal Reserve Bank of New York, issue 24-2, pages 71-90.
    8. Simona E. Cociuba & Malik Shukayev & Alexander Ueberfeldt, 2019. "Managing Risk Taking With Interest Rate Policy And Macroprudential Regulations," Economic Inquiry, Western Economic Association International, vol. 57(2), pages 1056-1081, April.
    9. Huh, Yesol & Infante, Sebastian, 2021. "Bond market intermediation and the Role of Repo," Journal of Banking & Finance, Elsevier, vol. 122(C).
    10. Meraj Allahrakha & Jill Cetina & Benjamin Munyan & Sumudu Watugala, 2019. "The Effects of the Volcker Rule on Corporate Bond Trading: Evidence from the Underwriting Exemption," Working Papers 19-02, Office of Financial Research, US Department of the Treasury.
    11. Bicu-Lieb, Andreea & Chen, Louisa & Elliott, David, 2020. "The leverage ratio and liquidity in the gilt and gilt repo markets," Journal of Financial Markets, Elsevier, vol. 48(C).
    12. Dong Beom Choi & Michael R. Holcomb & Donald P. Morgan, 2018. "Bank leverage limits and regulatory arbitrage: new evidence on a recurring question," Staff Reports 856, Federal Reserve Bank of New York.
    13. Bicu, Andreea & Chen, Louisa & Elliott, David, 2017. "The leverage ratio and liquidity in the gilt and repo markets," Bank of England working papers 690, Bank of England, revised 19 Dec 2017.

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    More about this item

    Keywords

    Banking; Leverage ratio; Heightened prudential regulation; Repurchase agreement; Global systemically important banks; Regulatory impact assessment;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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