Leverage Rule Research Articles

Central Counterparties and Liquidity Provision in Cash Markets

This paper investigates increased liquidity provision by market makers resulting from their ability to reduce balance sheet encumbrance through the use of central counterparties (CCPs). The introduction of the Basel III leverage rule constitutes a shock to market makers’ balance sheets and thus affects their capacity to intermediate trades. Using trade-by-trade data from sovereign bond markets, we show that liquidity provision by CCP members decreased to a lesser extent following the rule change. We attribute these findings to balance sheet reductions due to the netting enabled by CCPs, thereby highlighting their importance in cash markets.

Bank Leverage Limits and Regulatory Arbitrage: Old Question‐New Evidence

AbstractBanks are regulated more than most firms, making them good subjects to study regulatory arbitrage (avoidance). Their latest arbitrage opportunity may be the new leverage rule covering the largest U.S. banks; leverage rules require equal capital against assets with unequal risks, so banks can effectively relax the leverage constraint by increasing asset risk. Consistent with that conjecture, we find that banks covered by the new rule shifted to riskier, higher yielding securities relative to control banks. The shift began almost precisely when the rule was finalized in 2014, well before it took effect in 2018. Security level analysis suggests banks actively added riskier securities, rather than merely shedding safer ones. Despite the risk shifting, overall bank risk did not increase, evidently because the banks most constrained by the new leverage rule significantly increased leverage capital ratios.

Roughness-Induced Friction on Liquid Foams.

Complex liquids flow is known to be drastically affected by the roughness condition at the interfaces. We combined stresses measurements and observations of the flow during the motion of different rough surfaces in dry liquid foams. We visually show that three distinct friction regimes exist: slippage, stick-slip motion, and anchored soap films. Our stress measurements are validated for slippage and anchored regimes based on existing models, and we propose a leverage rule to describe the stresses during the stick-slip regime. We find that the occurrence of the stick-slip or anchored regimes is controlled by the roughness factor, defined as the ratio between the size of the surface asperities and the radius of curvature of the Plateau borders.

Leverage Limits and Bank Risk: New Evidence on an Old Question

Banks are regulated more than most firms, making them good subjects to study regulatory arbitrage (avoidance). Their latest arbitrage opportunity may be the new leverage rule covering the largest U.S. banks; leverage rules require equal capital against assets with unequal risks, so banks can effectively relax the leverage constraint by increasing asset risk. Consistent with that conjecture, we find that banks covered by the new rule shifted to riskier, higher yielding securities relative to control banks. The shift began almost precisely when the rule was finalized in 2014, well before it took effect in 2018. Security-level analysis suggests banks actively added riskier securities, rather than merely shedding safer ones. Despite the risk-shifting, overall bank risk did not increase, evidently because the banks most constrained by the new leverage rule significantly increased leverage capital ratios.

Bank capital: the case against Basel

Purpose – The purpose of this paper is to focus on the “Basel Illusion”, the belief that a model-driven quantitative approach to capital adequacy can lead to a more robust and shock-proof system. The author analyzes the Basel framework and its role as a major source of systemic risk. Furthermore, the Basel framework is unlikely to enhance the safety of the financial system and prevent future crises. As such, Basel should be scrapped and regulators should revert to a simple tangible common equity (TCE) leverage rule. Design/methodology/approach – The paper aims to review the extensive existing literature and analytic approach to the problem, trying to answer the question: why Basel? The paper looks at the Basel methodology of calculating risk-weighed assets. Findings – The paper looks at the basic reasons underlying the Basel failure: complexity, variations in measurement of risk-weighed assets across banking institutions, ability to game the system and amplification of systemic risk. The research concludes that a simple TCE leverage rule is superior to Basel in controlling systemic risk. Research limitations/implications – Further research will be needed in determining the “optimal” level of capital. Practical implications – Regulators and bankers should seek simplicity in capital rules. The dubious use of quantitative models can only lead to spurious precision. Originality/value – This article synthesizes an extensive body of work on the issue of bank capital to demonstrate the superiority of a simple capital rule.

Financial Regulation after the Crisis: How Did We Get Here, and How Do We Get Out?

Following the crisis of 2007, regulatory authorities either are or should be engaging in a fundamental reconsideration of how they approach financial regulation and supervision. This paper briefly summarizes the present international consensus on regulation as embodied in the Basel framework, looks at how we came to be in such a situation, and proposes a re-start of the process that has been organized by the Basel Committee on Bank Supervision. It reviews the flaws of that framework and concludes that its weaknesses are fundamental, in its neglect of the endogeneity of risk to the regulatory structure, and of the dynamic nature of finance, and thus of its regulation as well. Neither a static rulebook, nor an ever increasingly complex one, will ever provide financial safety and soundness. Specific recommendations are made, starting with an abandonment of risk weights and the adoption of a simple leverage rule, supplemented by CoCos, and some simple rules. More radically, a different approach is urged, one that focuses on the oversight and accountability of regulators and greater transparency, both of banks and of the regulatory process.

Adaptive pairs trading strategy performance in Turkish derivatives exchange with the companies listed on Istanbul stock exchange

We implemented model-driven statistical arbitrage strategies in Turkish equities market. Trading signals are generated by optimized parameters of distance method. When the trade in signal is triggered by the model, market-neutral portfolio is created by long in the synthetic ETF, which is based on constrained least squares regression of selected Istanbul Stock Exchange stocks and short in Turkish Derivatives Exchange (Turkdex) index futures contract. We performed pairs trading strategy based on a comparative mean reversion of asset prices with daily data over the period February 2005 through July 2011 in Istanbul Stock Exchange (ISE) and Turkdex. We constructed a hypothetical ISE30 ETF Index on a daily basis in order to originate pairs trading strategy with Turkdex. Because of the leverage rule of (1–10) index futures contracts, we had to evaluate spot stock pairs formation with futures contracts pairs strategy. The results indicate that applied pairs strategy produced overall returns of 901 per cent during the investment period, whereas naive strategy (buy and hold ISE-30 index) return for the same period was 111 per cent. Similar outperformance was observed in the Sharpe and Sortino ratios.

Optimal leverage association rules with numerical interval conditions

In this paper we propose a framework for defining and discovering optimal association rules involving a numerical attribute A in the consequent. The consequent has the form of interval conditions A, A≥ x or A ∈ I where I is an interval or a set of intervals of the form [x_l,x_u. The optimality is with respect to leverage, one well known association rule interest measure. The generated rules are called Maximal Leverage Rules MLR and are generated from Distribution Rules. The principle for finding the MLR is related to the Kolmogorov-Smirnov goodness of fit statistical test. We propose different methods for MLR generation, taking into account leverage optimallity and readability. We theoretically demonstrate the optimality of the main exact methods, and measure the leverage loss of approximate methods. We show empirically that the discovery process is scalable.

Polyelectrolyte complexes: Bulk phases and colloidal systems

When aqueous solutions of polycations and polyanions are mixed, polyelectrolyte complexes form. These are usually insoluble in water, so that they separate out as a new concentrated polymer phase, called a complex coacervate. The behavior of these complexes is reviewed, with emphasis on new measurements that shed light on their structural and mechanical properties, such as cohesive energy, interfacial tension, and viscoelasticity. It turns out that stoichiometric complexes can be considered in many respects as pseudo-neutral, weakly hydrophobic polymers, which are insoluble in water, but become progressively more soluble as salt is added. In fact, the solubility-enhancing effect of salt is quite analogous to that of temperature for polymers in apolar solvents.Since two-phase systems can be prepared in colloidal form, we also discuss several kinds of colloids or ‘microphases’ that can arise due to polyelectrolyte complexation, such as thin films, ‘zipper’ brushes, micelles, and micellar networks. A characteristic feature of these charge-driven two-phase systems is that two polymeric ingredients are needed, but that some deviation from strict stoichiometry is tolerated. This turns out to nicely explain how and when the layer-by-layer method works, how a ‘leverage rule’ applies to the density of the ‘zipper brush’, and why soluble complexes or micelles appear in a certain window of composition. As variations on the theme, we discuss micelles with metal ions in the core, due to incorporation of supramolecular coordination polyelectrolytes, and micellar networks, which form a new kind of physical gels with unusual properties.

The elephant in the room: The need to deal with what banks do

Contagion risk and counterparty failure have been the main hallmarks of the current crisis. While some large diversified banks that focused mainly on commercial banking survived very well, others suffered crippling losses. Sound corporate governance and strong riskmanagement culture should enable banks to avoid excessive leverage and risk taking. The question is whether there is a better way, via leverage rules or rules on the structures of large conglomerates, to ensure volatile investment banking functions do not dominate the future stability of the commercial banking and financial intermediation environment that is so critical for economic activity. While there is a main consensus on the need for reform of capital rules, dynamic provisioning, better co-operation for future crises, centralised trading of derivatives etc., the question is whether such reforms will be sufficient if they do not address contagion and counterparty risk directly. The world outside of policy making is waiting for a fundamental reassessment of banks’ business models: what banks are supposed to do and how they compete with each other. It is the “elephant in the room” on which some policy makers have not yet had the time or inclination to focus. This article emphasises not only the need for transparent and comparable accounting rules and for improvements in corporate governance, but also supports the imposition of a group leverage ratio to provide a binding capital constraint (that Basel riskweighted rules have been unable to achieve) and proposes a NonOperating Holding Company Structure (NOHC) – reforms that are essential to deal with contagion and counterparty risk that are so integral to the ‘too big to fail’ issue.

Direct determination of the coexistence region in the solid solutions Pb(ZrxTi1-x)O3

By means of X-ray diffraction, the authors have determined directly the coexistence region near the morphotropic phase change of the PZT, where the tetragonal and the rhombohedral phases coexist. In this region the lattice parameters of each phase do not change, and the relative amounts obey the leverage rule. The authors show that the morphotropic phase change may be considered as a first-order transition as a function of the temperature and the chemical potential (and not the concentration, as often supposed).