The Leverage Ratio – a simple backstop measure

in Financial Services, 27.01.2014

In the aftermath of the 2008 crisis, the leverage ratio was introduced as a response to the excessive build-up of on- and off-balance sheet leverage in the banking system. In contrast to the complex rule framework to calculate risk-based capital requirements, the ratio was designed as a simple backstop measure to complement the existing rules, and restrict the build up of leverage. The original Basel III text set out a transition period until 2017, in which the calculation will be further calibrated and definition adjusted.

Updated rules

As part of the calibration process, the updated Basel III leverage ratio framework, published in early January 2014 and followed by much media fanfare, has got everyone discussing the impact and regulatory concessions to the banking sector.

So what has changed?

Key changes include:

  • Allowing for netting of cash variation margin collateral with exposures from the derivative business under certain conditions, which will reduce the exposure measure.
  • Exclusion of certain trades associated with client-cleared derivative transactions with Qualified Central Clearing Parties from the exposure measure, under certain conditions.
  • A relaxation of the requirement to convert off balance sheet exposures at 100% for certain commitments, which may help to incentivise lending.
  • Limited netting for Securities Financing Transactions, with the same counterparty, under certain conditions.
  • Capping the effective notional amounts, included in the exposure measure, of written credit derivatives at the level of maximum potential loss.

Anything else I should know?

One change did not occur, the regulators left the minimum floor for the ratio at 3% as it was originally designed. National regulators are free to impose higher ratios, and some are already expected to go in this direction – the US Federal Reserve is considering raising the hurdle to even 5% or 6%. Banks operating under regulators which do not prescribe a stricter minimum floor may experience a comparative business advantage, in being allowed to hold less capital and leverage further. There will be more debate to come on this topic over the transition period, regarding consistent and comparable application and whether the 3% ratio is an acceptable response to the issues highlighted in the last crisis.

Further information

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