Modelling bank leverage and financial fragility under the new minimum leverage ratio of Basel III regulation

We analyse the determinants of banks’ balance sheet and leverage ratio dynamics, and its role in increasing financial fragility. Our results are twofold. First, we show there exists a value of bank leverage minimising financial fragility. Second, this value depends on the overall business climate and the expected value of the collateral provided by firms. Based on our findings, we argue that an adjustable leverage ratio restriction dependent on economic conditions would be preferable to the fixed ratio included in the new Basel III regulation.