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Leverage Ratio Arbitrage All Over Again

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Abstract

Leverage limits as a form of capital regulation have a well-known, potential bug: If banks can’t lever returns as desired, they can boost returns on equity by shifting toward riskier, higher yielding assets. That reach for yield is the leverage rule “arbitrage.” But would banks do that? In a previous post, we discussed evidence from our working paper that banks did do just that in response to the new leverage rule that took effect in 2018. This post discusses new findings in our revised paper on when and how banks arbitraged.

Suggested Citation

  • Dong Beom Choi & Michael R. Holcomb & Donald P. Morgan, 2020. "Leverage Ratio Arbitrage All Over Again," Liberty Street Economics 20200630, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednls:88260
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    More about this item

    Keywords

    leverage rule; regulatory arbitrage; risk; banks;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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