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Procyclicality and Bank Portfolio Risk Level Under A Constant Leverage Ratio

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  • Olivier Bruno

    () (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - CNRS - Centre National de la Recherche Scientifique)

  • Alexandra Girod

    (GREDEG - Groupe de Recherche en Droit, Economie et Gestion - UNS - Université Nice Sophia Antipolis - UCA - Université Côte d'Azur - CNRS - Centre National de la Recherche Scientifique)

Abstract

We investigate the impact the risk sensitive regulatory ratio may have on banks' risk taking behaviours during the business cycle. We show that the risk sensitivity of capital requirements introduce by Basel II adds either an "equity surplus" or an "equity deficit" on a bank that owns a fixed capital endowment and a constant leverage ratio. Depending on the magnitude of cyclical variations into requirements, the "surplus" may be exploited by the bank to increase its value toward the selection of a riskier asset or the "deficit" may restrict the bank to opt for a less risky asset. Whether the optimal asset risk level swings among classes of risk through the cycle, the risk level of bank's portfolio may increase during economic upturns, or decrease in downturns, leading to a rise in financial fragility or a "fly to quality" phenomenon.

Suggested Citation

  • Olivier Bruno & Alexandra Girod, 2013. "Procyclicality and Bank Portfolio Risk Level Under A Constant Leverage Ratio," Working Papers halshs-01295573, HAL.
    • Handle: RePEc:hal:wpaper:halshs-01295573
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-01295573
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    References listed on IDEAS

    as
    1. Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
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    6. Tobias Adrian & Hyun Song Shin, 2010. "The Changing Nature of Financial Intermediation and the Financial Crisis of 2007–2009," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 603-618, September.
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    More about this item

    Keywords

    risk incentive; Bank capital; Basel capital accord;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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