ECB: removing repo from the Leverage Ratio would be a bad idea

This article summarises the key findings from a counterfactual exercise where the effect of removing repo assets from the leverage ratio on banks’ default probabilities is considered. The findings suggest that granting such an exemption may have adverse effects on the stability of the financial system, even when measures are introduced to compensate for the decline in capital required by the leverage ratio framework. Increases in probabilities of default are mainly seen for larger banks which are more active in the repo market. Moreover, it is observed that the predictive power of the model improves when repo assets are included. Overall, the analysis in this article does not support a more lenient treatment of repo assets in the leverage ratio framework, e.g. by exempting them or allowing for more netting with repo liabilities or against high-quality government bonds.

The full article is available at https://www.ecb.europa.eu/pub/macroprudential-bulletin/html/ecb.mpbu201810_01.en.html

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