The leverage ratio was intended to act as a backstop measure. A ratio of above 3%, however, could become an effective non-risk-sensitive capitalisation threshold for banks, unfairly punishing low-risk and high-volume business models. ESBG has been active on this issue, successfully arguing for the exclusion of intracompany transactions at the entity level calculation from the 2014 EU Commission delegated act, which would have led to punitive treatment of de-centralised banks compared to their more centralised competitors.
Updated: January 2017
ESBG members believe that the leverage ratio discourages the investment in low-risk exposures unless the yield can be increased. The lack of differentiated risk weights in the leverage ratio calculation will indeed increase the capital required for these exposures. A higher leverage ratio in Europe would counteract the general objective of strengthening a heterogeneous and diversified banking market structure in Europe and disturb the transfer of credits to the real economy, particularly to well-performing small and medium-sized enterprises.
The leverage ratio favours higher-risk investments that yield a comparatively higher return. For many ESBG members, a leverage ratio above 3% would become the primary binding capital measure unless they opt for a change in the risk profile of their portfolios towards higher-risk, higher-yield instruments, e.g. by reducing their lending to low-risk customers. Due to its lack of risk weights, the leverage ratio must remain a backstop measure in order for these customers not to be unduly punished by increased costs and/or a reduced supply of credit in the market. The leverage ratio must also not be considered a tool for addressing any perceived weaknesses in the RWA measure.
The leverage ratio is a tool that will allow competent authorities to assess the risk of excessive leverage in their respective institutions. The CRD IV/CRR introduced a leverage ratio that is based on the BCBS Basel III Framework. Since the publication of the Basel III Framework in December 2010, the BCBS has further refined the exposure measurement of the leverage ratio and has developed a uniform format for leverage ratio disclosure. In October 2014 the Commission adopted delegated acts under the CRR establishing a common definition of the leverage ratio, which was the basis for the leverage ratio calculated and disclosed by institutions from January 2015 onwards.
The EBA is currently working on a Leverage Ratio Calibration Report which will be finalised and submitted to the European Commission by July 2016. The Commission will then draft a legislative proposal by the end of 2016.
Basic lending products provide a lower return than more advanced structured and higher-risk products. Financial institutions that operate mainly according to a business model that focuses on these products must supply higher volumes of products. This is in order to achieve the same profitability as competitors that supply products with greater margins.
The increased volume of low-risk products will inflate the asset-base, requiring these institutions to hold a higher proportion of tier 1 capital. A risk-neutral capital ratio, such as the leverage ratio, would be a significant drawback in this situation, as in practice it would not be risk-neutral at all. It would make it more profitable for financial institutions to operate a business model in which they supply higher-risk structured products that provide a greater return, as fewer assets would be required to obtain the same level of profitability.
Widely considered as a backstop measure that is completely insensitive to risk, the leverage ratio in its crudest form is defined as the proportion of equity to assets or as an institution’s tier 1 capital divided by its average total consolidated assets. The Leverage Ratio indicates the proportion of assets that would be covered by equity in case of default.
The BCBS and the EBA offer different definitions of the leverage ratio calculation, with the key difference being that the EBA requires the ratio to be reported at an entity level, whereas the BCBS only requires the ratio at the consolidated level. There is currently no binding standard for the leverage ratio at European level as it is under observation. Implementation of the leverage ratio requirement began with bank-level reporting to supervisors of the leverage ratio and its components from 1 January 2013, and public disclosure started on 1 January 2015. Any final adjustments to the definition and calibration of the leverage ratio will be made by 2017, with a view to migrating to a Pillar 1 treatment on 1 January 2018.