Banks’ ability to temporarily contract their balance sheets around reporting dates to report more favourable regulatory metrics – a regulatory arbitrage practice commonly referred to as window dressing – poses a risk to financial stability. In this paper, we investigate both the magnitude and the drivers of bank window dressing behaviour in euro-denominated repo markets. Using a confidential transaction-level data set, our analysis illustrates that banks engineer an economically sizeable contraction in their repo exposures around regulatory reporting dates. We establish a causal link between these reductions and banks’ incentives to window dress and document the role of the leverage ratio and the G-SIB framework as the most relevant drivers of window dressing behaviour. Our findings suggest that regulatory action is warranted to limit banks’ ability to window dress.
Link: Window dressing of Regulatory Metrics: Evidence from Repo Markets