Liberty Street — Blog of FRBNY Leverage Ratio Arbitrage All Over Again

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....

Liberty Street Economics — Blog of FRBNY
Leverage Ratio Arbitrage All Over Again
Donald P. Morgan, assistant vice president in the Federal Reserve Bank of New York’s Research and Statistics Group; Dong Beom Choi, assistant professor of finance at Seoul National University and previously an economist in the Bank’s Research and Statistics Group, and Michael R. Holcomb, Ph.D. student at Harvard’s Kennedy School of Government and previously a senior research analyst in the Bank’s Research and Statistics Group