Tag Archives: Sectoral Capital Requirements

Are mortgages like potatoes? Unintended consequences in a world of many constraints

Authors: Renzo Corrias and Tobias Neumann.

When banks are subject to both a leverage and a risk-weighted constraint they may violate a fundamental law of economics: that of demand. In our theoretical model, some banks constrained by the leverage ratio react to an increase in capital requirements by investing more in the asset. This so-called ‘Giffen’ behaviour is very counterintuitive.  One would assume the opposite to be the case: higher capital requirements should discourage lending. In our theoretical model, Giffen behaviour is likely to occur for firms that hold predominantly low-risk weighted asset and are therefore bound by the leverage ratio. The real-world equivalent in the context of mortgages would be building societies and, in the future, ring-fenced banks.
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Filed under Financial Stability, Macroprudential Regulation, Microprudential Regulation