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Sir, In your editorial “In praise of bank leverage ratios”, you seem to imply that some regulators and the financial services industry object to implementing a leverage ratio as a backstop measure to ensure sound and robust bank capitalisation. On the contrary, a 3 per cent leverage ratio is now an integral part of the Basel III framework and is being implemented, with support from the industry, in all major jurisdictions, including the EU.
It is a different matter, however, to abandon risk-sensitive capital frameworks and adopt a crude measure such as the leverage ratio as the binding driver of regulatory capital. Nothing but a false sense of safety would come out of such a framework, which would bring us back to the pre-Basel I era, hardly a model of perfect financial stability.
Yes, there were deficiencies with Basel II risk weights. But substantial progress has been made through Basel 2.5 and III, in particular in the areas where the crisis evidenced fundamental problems: securitisations, counterparty risk and off-balance sheet exposures.
Abandoning appropriate risk sensitivity in capital frameworks, either by relying on a non-risk-based leverage ratio or by adopting standardised approaches may appeal as “simple, straightforward” measures. However, it takes a leap of faith to assume that policy makers will necessarily get standard risk weights right. Given the lessons of the crisis, it would be unwise to rely on a measure that does not take into account the riskiness of banking assets. Financial risk evolves with time and a hard-coded approach will not do. Let’s focus on strengthening the existing framework and avoid incentivising firms to shift to the riskiest assets, which could only sow the seeds of another crisis.