CRS Finds “Binding Leverage Requirements” May Incentivize Behavior Counter to Financial Stability

The Congressional Research Service ("CRS") found that "binding" leverage requirements on large banking organizations may be "incentivizing behavior counter to financial stability."

In a report, CRS examined the ways in which different capital requirements "influence capital structure at the largest banks." The analysis included 34 large bank holding companies that were subject to the Federal Reserve Board’s 2022 stress test.

Under a purely risk-based regime, the CRS analyst explained that when there are two banks with the same size assets but one held risker assets, the bank with the riskier assets would be required to hold more capital. According to the report, issues arise when "the leverage requirement is binding," because all assets then "require the same amount of capital" which creates conditions in which there is "less incentive to hold safe assets."

CRS found that binding capital requirements are still largely based on risk rather than size. However, CRS stated that because the amount of capital "required under risk-weighted and leverage ratios" was close for the G-SIBs and several other large institutions, more banking organizations may be "bound by leverage requirements in the future."

CRS recommended that Congress and regulators consider whether the "relative levels of capital standards based on risk and size remain properly aligned with risk-based prudential incentives."