Banks’ internal capital allocation, the leverage ratio requirement and risk-taking

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 17 December 2021

Staff Working Paper No. 956

By Ioana Neamtu and Quynh-Anh Vo

This paper examines how banks’ asset risk is affected by the level (ie group or business unit) at which regulatory requirements are applied. We develop a theoretical model and calibrate it to UK banks. Our main finding is that the impact differs depending on which regulatory constraint is binding at the group level. If that is the leverage ratio requirement, then the allocation of regulatory constraints to business units either maintains or decreases the riskiness of banks’ investment portfolios. However, if the risk-weighted requirement is the binding constraint at the group level, applying regulatory requirements at the business unit level can lead to banks selecting riskier asset portfolios as optimal. We also find that the impact on banks’ asset risk differs across bank business models.

This version was updated in May 2022.

Banks’ internal capital allocation, the leverage ratio
requirement and risk-taking

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