Bank regulation - the leverage ratio requirement from the perspective of stabilizing the financial system

The dissertation investigates the impact of a non-risk-weighted leverage ratio on the stability of financial institutions. We calculate leverage ratios (LR) and estimate probabilities of default (PD) and find a significant positive relationship between LR and PD. This might be explained by the fact that higher leverage ratios increase the cost of capital which in turn also increases interest rates that banks require for their loans. In fact, we find a significant positive relationship between LR and net interest margins. Following Stiglitz and Weiss (1981) increasing loan rates might attract borrowers who are more likely to default. This suggests that the potential introduction of a LR might lead to a destabilization of the banking sector since credit worthiness of borrowers might be reduced.