Back to the Future: The Nature of Regulatory Capital Requirements

IMF Working Papers, August 4, 2017

Source details

Canonical URL

Back to the Future: The Nature of Regulatory Capital Requirements

Other formats

• Markdown version
• Structured JSON version
• Bundle manifest

Bibliographic details

• Authors: Ralph Chami, Thomas F. Cosimano, Emanuel Kopp, Celine Rochon
• Published: August 4, 2017
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781484313817.001

Summary and main findings

• The paper compares current regulatory capital requirements under the Dodd-Frank Act (DFA) with a 10-percent leverage ratio proposal advanced by the U.S. Treasury and the U.S. House Financial CHOICE Act (FCA).
• Majority of U.S. banks would not qualify for an "off-ramp" option—where regulatory relief is offered to FCA qualifying banks (QBOs)—unless considerable amounts of capital are added.
• Large banks are much closer to the proposed leverage threshold and are therefore more likely to gain from regulatory relief.
• The paper identifies an important moral hazard problem arising from QBO optionality: banks are likely to increase the riskiness of their asset portfolios to qualify for FCA “off-ramp” relief, with unintended effects on financial stability.

Analysis and risks

• Moral hazard and portfolio-composition effects:
  • QBO optionality creates incentives for banks to raise measured leverage compliance by shifting asset composition toward higher-risk, higher-yielding assets.
  • Such shifts can undermine financial stability by increasing system-wide risk despite meeting a leverage-ratio-based off-ramp.
• Distributional impact across banks:
  • Large banks are closer to the 10-percent leverage threshold relative to smaller banks, implying asymmetric gains from any off-ramp relief.

Policy implications and considerations

• Eligibility design:
  • Off-ramp criteria should account for incentives that encourage riskier asset portfolios to prevent erosion of financial-stability objectives.
• Capital adequacy framework:
  • Policymakers should consider interactions between leverage-based relief and risk-weighted capital requirements to avoid regulatory arbitrage and perverse portfolio incentives.
• Supervision and monitoring:
  • Enhanced supervisory scrutiny may be required if optionality is introduced to detect shifts in portfolio risk-taking that exploit the off-ramp.

Content in this bundle

• Back to the Future: The Nature of Regulatory Capital Requirements, WP/17/181, August 2017
  • Back to the Future: The Nature of Regulatory Capital Requirements, WP/17/181, August 2017 (Markdown version)
  • Back to the Future: The Nature of Regulatory Capital Requirements, WP/17/181, August 2017 (PDF)