Optimal Leverage Ratio and Capital Requirements with Limited Regulatory Power

Ho-Mou Wu (First Author), Yue Zhao (Participant Author)

Research output: Contribution to journalJournal

5 Citations (Web of Science)

Abstract

This article discusses the optimal leverage ratio and capital requirements when asymmetric information exists between the bank and the regulator. We show that the optimal requirements take different forms in the short and long run. In either case, imposing the risk-weighted capital requirement without considering the incentives of the bank to misreport its risk profile is never optimal by itself. In the long run, the optimal requirements take the form of a leverage ratio requirement on top of the risk-weighted capital requirement. The add-on leverage ratio requirement, which serves as a compensation for the limited supervisory power of the regulators, should be set such that the risk-taking behavior of the bank is unchanged from the situation in which the regulator uses the risk-weighted capital requirement alone, and the misreporting incentive of the bank is eliminated by the add-on leverage ratio requirement.
Original languageEnglish
Pages (from-to)2125-2150
JournalReview of Finance
Volume20
Issue number6
DOIs
Publication statusPublished - 2016

Indexed by

  • FT
  • ABDC-A*
  • Scopus
  • SSCI

Fingerprint

Dive into the research topics of 'Optimal Leverage Ratio and Capital Requirements with Limited Regulatory Power'. Together they form a unique fingerprint.

Cite this