Download Marginal leverage ratio as a monitoring tool of

Javier Villar Burke
European Commission and Universidade de Santiago de Compostela
[email protected], http://ssrn.com/author=2026420
Marginal leverage ratio
as a monitoring tool of systemic risk
Macroprudential Regulation: Policy Dynamics and Limitations, Dublin, January 2016
Definition of leverage:
a relative measure of debt
The marginal leverage ratio
Absolute vs. marginal leverage
TA
D
TA
EQ
EQ
D
D
TA
EQ
TA
D
EQ
The leverage can be defined as a relative measure of debt. In
principle, this can be done by a ratio combining any two variable
from debt, total assets and equity.
However, not all such ratios are equaly valid. Effects like wrong
framing and denominator neglect indicate that what we are trying to
measure, i.e. debt, should appear in the numerator. Furthermore, the
one of the components of the ratio should be contained within the
other.
Given these criteria, we are left with only two valid measures of
leverage: TA / EQ and D / TA. In this paper-poster, we use the
former definition.
Euro area banks, number of times
This paper proposes an innovative approach to leverage based on
flows using the concept of a marginal leverage ratio as a valuable
supplement to the traditional absolute leverage ratio.
Besides capturing the leveraging-deleveraging cycles better than the
absolute leverage ratio, the marginal leverage ratio provides an
indication of risks that a stable absolute leverage ratio can conceal.
Notes: The absolute leverage ratio is computed as total assets to total equity. The marginal
leverage ratio is computed as annual net flows of total assets to annual net flows of equity.
Annual flows are computed as the sum of monthly flows for twelve consecutive months in a
rolling window. "Net" refers to new transactions minus redemptions.
Therefore, the marginal leverage ratio can be used as an early
warning tool to signal potential episodes of excessive leverage and
to understand if, and how, banks deleverage.
Source: ECB Statistical Data Warehouse and own calculations.
Motivation
Country examples
Euro area
Germany
France
Italy
Eurostoxx 600
Leverage ratio
Jan-Feb 2000 = 100
Ratio of total assets to equity, number of times
Source: Bloomberg and own calculations.
Source: ECB Statistical Data Warehouse and own calculations.
Basel III explains the risks embedded in leverage: "One of the underlying features of the crisis was the build-up of excessive leverage in the
banking system. […] During the most severe part of the crisis, the banking sector was forced to reduce its leverage in a manner that amplified
downward pressure on asset prices, further exacerbating the positive feedback loop between losses, declines in bank capital, and the contraction
in credit availability" (paragraph 152).
Spain
Ireland
The evolution of stock markets provides a clear example of the dynamics described by Basel III (i.e. the inflation and deflation of bubbles).
However, the evolution of leverage does not seem to follow such a pattern.
Are there some flaws in BIS predictions or rather on how leverage is measured? This paper provides a new approach to leverage which captures
these risk dynamics embedded in the concept of leverage.
Source: ECB Statistical Data Warehouse and own calculations.
Further analysis
This paper constitute a first approach to the concept of marginal
leverage ratio.
Further anlayis is needed with respect to how to treat extreme
values.
Furthermore, a micro analysis at bank level could help explain the
differences observed across countries. Futhermore, this analysis
would allow to understand whether marginal leverage ratio is
correlated across banks within a country or, on the contrary, banks'
leverage behaviour is independent from that of their close
compentitors.
Leverage components: total assets and equity
Total assets and equity, volume
Total assets and equity, net annual flows
Euro area banks, € billion
Euro area banks, € billion
Source: ECB Statistical Data Warehouse and own calculations.
Source: ECB Statistical Data Warehouse and own calculations.
Bank assets can have a very large maturity (i.e. up to 30 years or longer for mortgages).
As a consequence, the outstanding volume of assets is much larger than the assets that are agreed every years (flows).
This “inertia” of volumes conceals the significant variability of new activities as observed in net annual flows.