A leverage ratio rule for capital adequacy

• Published in: Journal of banking & finance Vol. 37; no. 3; pp. 973 - 976
• Main Author: Jarrow, Robert
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.03.2013; Elsevier Sequoia S.A
• Subjects: Capital adequacy rules; Capital maintenance; Capital requirements; Collateral requirements; Comparative analysis; Financial management; Financing methods; Haircuts; Insolvency; Leverage; Leverage ratios; Probability; Risk; Risk assessment; Studies; Value-at-risk; Haircuts; Capital adequacy rules; Leverage ratios; Collateral requirements; G21; E58; G28; Value-at-risk
• ISSN: 0378-4266; 1872-6372
• DOI: 10.1016/j.jbankfin.2012.10.009

► This paper studies the maximum leverage ratio rule for capital adequacy. ► We derive the leverage ratio consistent with an alpha probability of insolvency. ► We show that leverage ratio and a value-at-risk rules control for the same risks. ► We argue that leverage ratio rules are intuitive and easy to compare across firms. This paper studies the economic foundations for maximum leverage ratio capital adequacy rules. The paper makes three contributions to the literature. First, we show how to determine the maximum leverage ratio such that the probability of insolvency is less than some predetermined quantity. Two, we show that a leverage ratio rule controls for the same risks as does a Value-at-Risk (VaR) capital adequacy rule. Third, we argue that leverage ratio rules are better than VaR rules because they are more intuitive and easier to compare across firms.