We develop a dynamic model of banking to assess the effects of liquidity and leverage requirements on banks' insolvency risk. In this model, banks face taxation, flotation costs of securities, and default costs and maximize shareholder value by making their financing, liquid asset holdings, and...

The lack of portfolio granularity in terms of exposure has been shown to have important implications for the amount of a financial institution's economic capital. Based on a numerical simulation model, we provide concrete examples of how granularity affects capital levels. We achieve this by...

This paper studies the relationship between the riskiness of banks' assets and their average risk weight. Banks' initial risk weights explain about half of the variation in projected credit losses in the 2018 European Banking Authority stress test. In contrast to related papers, this paper also...

We examine the effects of the recently introduced regulatory leverage ratio, which aims to backstop existing risk-weighted capital requirements, on banks' balance sheets. We observe on average a deleveraging process, while banks simultaneously increase their risk-weighted assets. Having less...

We empirically assess the sensitivity of Basel risk weights to bank portfolio risk and the business cycle. With our econometric model, we distinguish between cross-sectional risk sensitivity and longitudinal risk sensitivity (cyclicality) of the regulatory standard. Employing a comprehensive...

We present a model where bank assets are a portfolio of risky debt claims and analyze stockholders' risk-taking behavior while considering the strategic interaction between debtors and creditors. We find that: (1) as the leverage of a bank increases, risk shifting by borrowers increases, even if...

Using supervisory data for US banks, we evaluate the alignment of Basel II/III AIRB (Advanced Internal Ratings Based) risk estimates with portfolio risk. We use loan performance as a direct measure of portfolio risk as well as less direct market-based measures. Our results document that loan...

The structural approach views firm's equity as a call option on the value of its assets, which motivates stockholders to increase risk. However, since bank assets are risky debt claims, bank equity resembles a subordinated debt. Using this assumption, and considering the strategic interaction...

We assess the impact of leverage ratio (LR) requirements on risk-taking behaviour of banks theoretically, using a simple model, and empirically, using a difference-in-differences analysis that compares behaviour of banks subject to UK LR requirements (LR-banks) to otherwise similar banks...