Leverage constraints: the Canadian experience

Leverage ceilings of the kind being proposed in international fora could be useful, argues a paper published by the Bank of Canada in December. The authors draw this conclusion based on the Canadian experience.

Banks in the country have been subject to a regulatory ceiling on an unweighted leverage ratio since the early part of the 1980s, and the authors find that leverage at the major Canadian banks was largely stable in the lead up to the crisis, compared to financial institutions in countries without the supervisory constraint.

"The role of a leverage constraint is to act as a complement - not a substitute- for risk-weighted measures of capital adequacy. More broadly, it should be viewed as one component of the regulatory regime, rather than as a substitute for other risk-management and supervisory practices," the authors argue.

They add then when designing an additional leverage requirement, it will be vital to deal with factors that might encourage banks to shift activity to off-balance sheet instruments, or riskier instruments.

Click here to read the paper