Basel III and bank leverage

Even though off-balance sheet (OBS) activities greatly contribute to bank risk, most financial indicators are essentially based on on-balance-sheet data. In this paper, we introduce a dynamic setting based on a Kalman filter procedure to study elasticity-based indicators of broad leverage. This approach enables the detection of the build-up in bank risk years before what the traditional assets to equity ratio measure pre-dicts. In this respect, most elasticity measures of leverage appear in line with the historical episodes, well tracking the cyclical pattern of bank leverage. Importantly, these time-varying indicators suggest that OBS banking exerts a stronger influence on bank leverage during expansion periods.