The leverage ratio, a non-risk-based prudential measure of a banks capital strength, has belatedly become a cause célèbre for bank-reformers, after UK chancellor George Osborne said he was open to the Bank of Englands (BoE) review of the capital rule ahead of the Basel deadline. As Euromoney has reported, BoE governor Mark Carney has been gunning for a more ambitious calibration of the rule after the government last year unexpectedly rejected the Independent Commission on Bankings 4.06% ratio and instead backed the 3% Basel minimum.
Amid the clamour for tighter leverage ratios, Osborne on Tuesday accepted the UK might need to set a higher baseline ratio, especially for ring-fenced banking groups, but placed the onus on the Financial Policy Committee (FPC) at the BoE to demonstrate how higher equity thresholds adopted before the 2018 Basel deadline would boost financial stability. Speaking to lawmakers in parliament on Tuesday, Carney reiterated the regulatory appeal of the leverage ratio and said the FPC would be able to complete the review within 12 months.
If I could pick one element that was essential to the performance of the Canadian banking system during the crisis it was the presence of a leverage ratio, he said. Regulators in the US and Switzerland are gunning for a 6% leverage ratio, above the Basel minimum, but, in both cases, its unclear whether banks will be permitted to exclude cash, US Treasuries, or derivatives from their total assets when calculating minimum equity thresholds.
The stakes are high. As JPMorgan concludes in a November note: Basel III regulations, including that on leverage ratios, are having a bigger impact on euro-area banks than their US counterparts, due to the bloated balance sheets of the former. Less than a third of euro-area bank balance sheets are used to support the domestic real economy, i.e. households and non-financial corporations. The equivalent ratio for US banks is close to 50%. Mechanically, euro-area bank balance sheets will have to contract by another 10 trillion to achieve the same 50% ratio of loans to the real economy over total assets.
The following charts highlight how the global deleveraging cycle, and rout in the securities-financing market, has much further to go amid capital-market orientated banks capital constraints even if regulators make good on their promise to implement the rule in a gradual fashion.
And the inevitable impact on growth as banks race to meet leverage rules: