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While the risk‐based requirements are intended to be the binding requirements for most banks in order to effectively correlate their capital levels with the actual risks they take, the LR’s objectives are to 1) ensure that an appropriate minimum level of capital is held against a banks’ non‐risk weighted assets at all times, in the event that the risk‐based measure fails to capture certain risks and 2) restrict the build‐up of leverage in the banking sector to avoid destabilizing deleveraging processes that can damage the broader financial system and the economy.
The industry welcomes the decision by the BCBS to consult on, and collect data to study, the impact of the LR on client cleared trades, with a view to potentially recognizing the exposure‐reducing effect of initial margin (IM). The industry believes that in the context of a bank exposure created by a client cleared derivative transaction, the LR framework should recognize the exposure‐reducing effect of IM, particularly as it is not used to increase the bank’s leverage. Not recognizing client IM in the calculation of LR exposure (LRE), as is the case under the current LR framework, unnecessarily and significantly overstates LRE and contradicts the G20 mandate by creating an economic disincentive for clearing brokers to offer clearing services.
Consequently, clearing services have become more expensive and the client clearing service providers’ (CCSP) capacity has been constrained, resulting in a number of CCSPs exiting the market. As evidenced in several papers1,2,3, this has had negative spill‐over effects for end‐users and their ability to hedge legitimate business risks in the cleared market, potentially pushing activity towards less efficient or more expensive hedging strategies.