10 July 2013

FT editorial: In praise of bank leverage ratios

There is a strong case for complementing the risk-weighted metric with a blunter tool: a leverage ratio, limiting how many assets can accumulate on given equity, regardless of their perceived risk. (Includes response from DG MARKT/Faull.)

Encouragingly, many regulators around the world believe strongly in this idea. The Basel Committee has decided that all global banks should meet a 3 per cent leverage ratio by 2018. This threshold will not be a problem for Asian banks. The Bank of England, the US and the Swiss watchdogs are all on board. The EU, which hosts some of the most over-leveraged lenders in the world, is regrettably still dragging its feet.

Some complain that this hurdle is too high. Yet the leverage ratio should be tough enough to bite. A threshold that is twice as high as the one agreed in Basel would not be a scandal.

Another complaint is that macro-prudential policy should be counter-cyclical: regulators should be more lenient when times are bad and show their teeth during a boom. But since most global banks did not have enough capital going into the crisis, they should strengthen their buffers now if they have not done so already.

Leverage ratios are not perfect. They encourage lenders to load up on the riskiest assets available, which offer higher returns for the same capital. But this is no argument for ditching them. Combining them with effective risk-weighted capital ratios is the way forward.

Full article (FT subscription required)

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Response from DG MARKT/Faull:

Sir, In your editorial “In praise of bank leverage ratios” (July 11) you bemoan the lack of commitment of the EU in implementing the leverage ratio. You may have missed the publication of EU legislation implementing the Basel III standards on June 27.

That legislation requires banks to calculate a leverage ratio and to disclose it starting from 2015, all in accordance with Basel III. It also explicitly asks both banks and supervisors to take into account the risks of excessive leverage when determining the appropriate levels of capital that banks should have. The international agreement provides that the leverage ratio requirement will not kick in before 2018. Since the EU intends to apply the leverage ratio as defined by Basel III to all its banks, not just a select few, it wants to use the time until 2018 for gathering information to understand better the implications of introducing binding leverage ratio requirements and to be able to calibrate such requirements appropriately.

In short, the EU is at the forefront of regulatory reform, and what the EU is doing is called better regulation, not dragging its feet.

Response (FT subscription required)

See also IIF/Adams response

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