## Back to the Future: The Nature of Regulatory Capital Requirements

_IMF Working Papers, August 4, 2017_

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**Canonical URL:** [Back to the Future: The Nature of Regulatory Capital Requirements](https://www.imf.org/en/publications/wp/issues/2017/08/04/back-to-the-future-the-nature-of-regulatory-capital-requirements-45160)

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## 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

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### 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.

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## Content in this bundle

- **Back to the Future: The Nature of Regulatory Capital Requirements, WP/17/181, August 2017**
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  - [Back to the Future: The Nature of Regulatory Capital Requirements, WP/17/181, August 2017 (PDF)](/-/media/files/publications/wp/2017/wp17181.pdf){rel="external" type="application/pdf"}

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_Source: https://www.imf.org/en/publications/wp/issues/2017/08/04/back-to-the-future-the-nature-of-regulatory-capital-requirements-45160_