Regulatory Constraints on Bank Leverage: Issues and Lessons from the Canadian Experience
The Basel capital framework plays an important role in risk management by linking a bank's minimum capital requirements to the riskiness of its assets. Nevertheless, the risk estimates underlying these calculations may be imperfect, and it appears that a cyclical bias in measures of risk-adjusted capital contributed to procyclical increases in global leverage prior to the recent financial crisis. As such, international policy discussions are considering an unweighted leverage ratio as a supplement to existing risk-weighted capital requirements. Canadian banks offer a useful case study in this respect, having been subject to a regulatory ceiling on an unweighted leverage ratio since the early 1980s. The authors review lessons from the Canadian experience with leverage constraints, and provide some empirical analysis on how such constraints affect banks' leverage management. In contrast to a number of countries without regulatory constraints, leverage at major Canadian banks was relatively stable leading up to the crisis, reducing pressure for deleveraging during the economic downturn. Empirical results suggest that major Canadian banks follow different strategies for managing their leverage. Some banks tend to raise their precautionary buffer quickly, through sharp reductions in asset growth and faster capital growth, when a shock pushes leverage too close to its authorized limit. For other banks, shocks have more persistent effects on leverage, possibly because these banks tend to have higher buffers on average. Overall, the authors' results suggest that a leverage ceiling would be a useful tool to complement risk-weighted measures and mitigate procyclical tendencies in the financial system.
|Date of creation:||2009|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: 613 782-8845
Fax: 613 782-8874
Web page: http://www.bank-banque-canada.ca/
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ayuso, Juan & Perez, Daniel & Saurina, Jesus, 2004. "Are capital buffers pro-cyclical?: Evidence from Spanish panel data," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 249-264, April.
- Xiujian Chen & Shu Lin & W. Robert Reed, 2005.
"Another Look At What To Do With Time-Series Cross-Section Data,"
- Xiujian Chen & Shu Lin & W. Robert Reed, 2006. "Another Look at what to do with Time-series Cross-section Data," Working Papers in Economics 06/04, University of Canterbury, Department of Economics and Finance.
- 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.
- Jaap Bikker & Paul Metzemakers, 2004.
"Is bank capital procyclical? A cross-country analysis,"
DNB Working Papers
009, Netherlands Central Bank, Research Department.
- Jacob A. Bikker & Paul A. J. Metzemakers, 2007. "Is Bank Capital Procyclical? A Cross-Country Analysis," Credit and Capital Markets, Credit and Capital Markets, vol. 40(2), pages 225-264.
- Andrews, Donald W K, 1993.
"Tests for Parameter Instability and Structural Change with Unknown Change Point,"
Econometric Society, vol. 61(4), pages 821-56, July.
- Donald W.K. Andrews, 1990. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Cowles Foundation Discussion Papers 943, Cowles Foundation for Research in Economics, Yale University.
- Hansen, Bruce E, 1996.
"Inference When a Nuisance Parameter Is Not Identified under the Null Hypothesis,"
Econometric Society, vol. 64(2), pages 413-30, March.
- Tom Doan, . "RATS programs to replicate Hansen's threshold estimation and testing results," Statistical Software Components RTZ00091, Boston College Department of Economics.
- Hansen, B.E., 1991. "Inference when a Nuisance Parameter is Not Identified Under the Null Hypothesis," RCER Working Papers 296, University of Rochester - Center for Economic Research (RCER).
- Tom Doan, . "TAR: RATS procedure to estimate a threshold autoregression, tests for threshold effect," Statistical Software Components RTS00209, Boston College Department of Economics.
- Jokipii, Terhi & Milne, Alistair, 2008.
"The cyclical behaviour of European bank capital buffers,"
Journal of Banking & Finance,
Elsevier, vol. 32(8), pages 1440-1451, August.
- Jokipii, Terhi & Milne , Alistair, 2006. "The cyclical behaviour of European bank capital buffers," Research Discussion Papers 17/2006, Bank of Finland.
- Jokipii, Terhi & Milne, Alistair, 2007. "The Cyclical Behaviour of European Bank Capital Buffers," SIFR Research Report Series 56, Institute for Financial Research.
- Elijah Brewer, III & George G. Kaufman & Larry D. Wall, 2008.
"Bank capital ratios across countries: why do they vary?,"
2008-27, Federal Reserve Bank of Atlanta.
- Elijah Brewer III & George Kaufman & Larry Wall, 2008. "Bank Capital Ratios Across Countries: Why Do They Vary?," Journal of Financial Services Research, Springer, vol. 34(2), pages 177-201, December.
- Rime, Bertrand, 2001. "Capital requirements and bank behaviour: Empirical evidence for Switzerland," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 789-805, April.
- Mark Illing & Graydon Paulin, 2004. "The New Basel Capital Accord and the Cyclical Behaviour of Bank Capital," Working Papers 04-30, Bank of Canada.
- Wall, Larry D. & Peterson, David R., 1987. "The effect of capital adequacy guidelines on large bank holding companies," Journal of Banking & Finance, Elsevier, vol. 11(4), pages 581-600, December.
When requesting a correction, please mention this item's handle: RePEc:bca:bocadp:09-15. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.