The leverage ratio over the cycle
Working Papers No 471
Published as "Are bank capital ratios pro-cyclical? New evidence and perspectives" (with M Brei), Economic Policy, 61st Panel Meeting, Bank of Latvia, Riga, 17-18 April 2015.
This paper analyses how the Basel III leverage ratio (Tier 1 capital/exposure) behaves over the cycle. The analysis proposes a setup to test for the cyclical properties of bank capital ratios, taking into account structural shifts in banks' behaviour during the global financial crisis and its aftermath. Using a large data set covering international banks headquartered in 14 advanced economies for the period 1995-2012, we find that the Basel III leverage ratio is significantly more countercyclical than the risk-weighted regulatory capital ratio: it is a tighter constraint for banks in booms and a looser constraint in recessions.
JEL classification: E43, E52, C32
Keywords: leverage, capital ratios, procyclicality, global financial crisis