BIS: The leverage ratio over the cycle

14 November 2014

This analysis proposes a setup for the cyclical properties of bank capital ratios, taking into account structural shifts in banks' behaviour during the global financial crisis and its aftermath.

This paper analyses how the Basel III leverage ratio (Tier 1 capital/exposure) behaves over the cycle. It tries to provide an an swer to three questions:

• Is the Basel III leverage ratio more countercyclical (less procyclical) than other capital ratios?
• What are the components included in the exposure measure definition (the denominator of the leverage ratio) that determine a different sensitivity to the cycle?
• Are results different in “normal times” as compared with a crisis period?

To this end, authors compared the new definition of the leverage ratio using the exposure measure as the denominator with alternative ratios (Tier 1/Total assets and capital-to-risk-weighted assets ratio).

To account for banks’ international activity, they have calculated business cycle measures for each bank as a weighted average across the jurisdictions in which the bank operates, using foreign claims data from the BIS international banking statistics.

The analysis has been conducted with bank-level data over the period 1995–2012, for which they reconstructed the new exposure measure using corrections at the country level derived from the Basel

Committee's Quantitative Impact Study database. The main results are the following:

• In normal 13 times the new leverage ratio based on the exposure measure is always more countercyclical (less procyclical) than the other ratios
• This result is driven by the inclusion of guarantees and other off-balance sheet items (credit lines, acceptances and other off-balance sheet items connected with securitisation activity) in the exposure measure definition (the denominator of the new Basel III leverage ratio)
• All three capital ratios tend to be less countercyclical (more procyclical) during the crisis period, especially when the credit gap indicator is considered

This might be explained by the reduced correlation of the denominator (which includes lending) with cyclical measures due to the recognition of losses or deleveraging practices.

Full working paper

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