Discussion Paper

Leverage Ratio Arbitrage All Over Again

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.

Keywords: leverage rule; reguatory arbitrage; risk; banks;

JEL Classification: G21; E5; G28;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Liberty Street Economics

Publication Date: 2020-06-30

Number: 20200630