Basel Committee Chairman Stefan Ingves has delivered a speech discussing the Basel III leverage ratio and its role in the Basel framework, noting that while the Basel Committee has recently agreed on a common measure of bank leverage, the issue of calibration (i.e., the percentage level of the leverage ratio) is still open. Significantly, Chairman Ingves stated that “[e]ven though the leverage ratio has been designed as a backstop, it must be a meaningful backstop if it is to serve its intended purpose.” In this respect, Chairman Ingves noted the following in his speech:
- “Only now that we have an agreed [measure of leverage] can the [Basel] Committee begin to turn to the issue of calibration, and the relationship of the leverage ratio to the risk-based framework. We have quite a bit of work to do to get this balance right.”
- “[T]he risk-based regime should be the binding constraint on most banks most of the time, supplemented by the leverage ratio as a backstop. But this goal has two important, albeit perhaps implicit, implications.”
- “The first is that the leverage ratio should be a meaningful backstop: it will only influence bank behaviour if it will conceivably become binding in some circumstances.”
- “[Second], while the risk-based regime should ideally be the binding constraint on most banks most of the time, that means the leverage ratio will be binding on at least some banks some of the time, and maybe even some banks most of the time.”
- “A requirement that does not constrain anyone at any time is not worth bothering with.”
- “Basel III needs to be looked at as a package of constraints that mutually reinforce prudent behaviour. So, a leverage ratio provides an absolute cap on leverage but, by itself, may also create an incentive to take on high-risk assets. The LCR [liquidity coverage ratio] compensates for this by preventing banks from imprudently running down their liquidity. And, of course, the risk-based framework would quickly constrain any bank that materially increased its risk profile without additional capital to support it.”
Other Basel III Leverage Ratio Developments and Related Resources
- U.S. G-SIB leverage surcharge proposal: In July 2013, the U.S. banking regulators proposed higher leverage capital standards for the 8 U.S. bank holding companies that have been identified as global systemically important banks (U.S. G-SIBs) and their insured depository institution (IDI) subsidiaries. The proposal would require a U.S. G-SIB’s IDI subsidiaries to maintain a Basel III leverage ratio of at least 6% to be considered “well-capitalized” for U.S. bank regulatory purposes. The proposal would also require U.S. G-SIBs to maintain a leverage capital buffer that would function in a similar way to the Basel III capital conservation buffer. A U.S. G-SIB that does not maintain a Basel III leverage ratio of greater than 5%, i.e., a buffer of more than 2% on top of the 3% minimum, would be subject to increasingly stringent restrictions on its ability to make capital distributions and discretionary bonus payments. U.S. banking regulators are expected to finalize this proposal shortly. Our memo on the U.S. G-SIB leverage surcharge proposal is available here.
- Basel Committee’s January 2014 revisions to the denominator of the Basel III leverage ratio: In January 2014, the Basel Committee finalized revisions to the denominator of the Basel III leverage ratio. U.S. banking regulators are expected to implement these revisions. Davis Polk’s visual memorandum, which uses diagrams, comparison tables, examples and formulas to illustrate the Basel Committee’s revisions to the denominator of the Basel III leverage ratio, is available here.
Materials: Stefan Ingves, Chairman of the Basel Committee, Banking on leverage (Feb. 26, 2014) available here: http://www.bis.org/speeches/sp140226.pdf.