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G20 up close: Leverage ratio

G20 up close: Leverage ratio

Higher-level leverage ratio would hit savings and retail banks hard

>> See the WSBI Intitutional Positions for G20 decision makers (.pdf)

​​​​​BRUSSELS, 5 October 2016 – In the recently released WSBI position paper to G20 decision makers, WSBI gives its stance on ​effective, efficient financial governance as it relates to the leverage ratio.

WSBI position

The BCBS released the finalised rules for leverage ratio reporting on 12 January 2014, these will enter into force on 1 January 2018. The publication clarified several outstanding items stemming from a consultation on the leverage ratio undertaken by the BCBS during the second half of 2013. That consultation (released on 26 June 2013) presented a common formula that measures tier 1 capital as a percentage of total assets, both on and off the balance sheet, without any adjustment for risk. The finalised rules addressed some question marks on the denominator by improving definitions in relation to the treatment of off-balance sheet items and written credit derivatives amongst others. 

In April 2016, the BCBS unexpectedly launched a consultation on proposed revisions to the Basel III leverage ratio framework. These proposed changes to the design and calibration of the leverage ratio framework have been informed by the monitoring process in the parallel run period since 2013, by feedback from market participants and stakeholders and by the frequently asked questions process since the January 2014 release of the standard Basel III leverage ratio framework and disclosure requirements. 

The deadline for responses to this consultation is 06 July 2016, thereafter, the final design and calibration of the proposals will be informed by a comprehensive quantitative impact study. 

WSBI firmly believes that it is imperative that the definition and requirements for the leverage ratio do not deflect the ratio from its original purpose within the Basel III rulebook as a simple backstop. Riskweighted capital ratios, in particular the CET1 ratio, should remain the most important capital measure as, in contrast to the leverage ratio, the CET1 ratio is based on a risk-sensitive approach.

A higher level of the leverage ratio would excessively penalise financial institutions whose primary business involve low risk and high volume instruments, such as savings and retail banks. Savings and retail banks are also characterised by a community focus which results in a more decentralised structure than, for example, a universal bank. This is why the leverage ratio should be capped at 3% and why it should only be applied at a consolidated level. If the leverage ratio is higher than 3% or applied at entity level, it will encourage banks to move towards riskier assets with higher returns.

Setting the leverage ratio above 3% would inevitably have an impact on the real economy too, for it would distort the ability of WSBI members to provide funding and credit to the MSME segment and penalise the provisioning of financial products that are more secure as the returns on these products might be insufficient to cover the cost of the required regulatory capital.

Although the leverage ratio should serve as a simple measure offering protection against model risks and uncertainties in risk measurement, it would disproportionally impact the lower risk segment as a flat rate capital charge will become binding for products with smaller margins first. WSBI believes that migrating the leverage ratio to Pillar I would bring unintended consequences such as an incentive to switch to riskier business given the same capital base or to specifically penalise low-risk business models.

The requested quarterly disclosure of the leverage ratio is, in WSBI’s opinion, excessive; annual disclosure intervals would be more suitable. Furthermore, the disclosure in the annual financial statements proposed is considered as inappropriate. It would be more appropriate to disclose the leverage ratio in combination with the supervisory ratios in the Pillar 3 reports.

WSBI is concerned by recent trends whereby individual nations both in North America and Europe have taken the initiative to set a higher level than the three percent limit proposed by the Basel Committee. Announcements from the US as well as the Dutch and UK regulators which welcome, or in the case of the US have already implemented higher levels of the leverage ratio, are of deep concern to WSBI and its members. We recognise that the US market is characterised by a higher level of securitisation than, for example, the European market and that it may, therefore, be advisable to have a different approach to the leverage ratio in the US as compared to Europe. However, WSBI firmly believes that different leverage ratio levels for countries with similar market structure would lay the foundation for an un-level playing field and would disproportionately punish financial institutions within the higher-rate jurisdictions. 

Leverage ratio; G20; SME finance