Benefits and Costs of a Higher Bank Leverage Ratio

Abstract

This study reports estimates of the marginal benefits and costs of increasing the regulatory minimum bank equity-to-asset “leverage ratio” from 4 to 15 percent. Benefits arise from reducing the probability of a banking crisis. Costs arise from reduced lending, should banks pass off higher equity costs onto borrowers. Net benefits increase with a higher discount rate, a smaller tax advantage of debt, a lower non-financial corporate debt-to-capital ratio, a higher cost of crises, a longer duration of crises or if crises have some permanent effects. Baseline estimates indicate that the benefits equal costs at 19 percent.