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Regulation: EU-US tensions remain over leverage ratio

US officials are waging a war to promote the leverage ratio as a binding constraint on banks’ capital frameworks, further imperilling strategic planning for cross-border lenders.

Jean-Claude Trichet

Six years after the global financial crisis, policymakers, mandated to end taxpayer-funded bank-bailouts, remain divided over the basic pillar of bank-regulation: which capital requirement best measures and caps risk.

The Basel Committee argues that risk-based capital guidelines for banks, which allow a bank to adjust its ratio of capital according to perceived risk, should be supplemented by a leverage ratio, a non-risk based measure of a bank’s capitalization. US officials, however, appear to prefer the latter as the binding constraint. The uncertainty over the interaction between both frameworks threatens to play havoc with lenders’ strategic plans and risk management, bankers say.

Far from a dry exercise in risk modelling, the outcome could also sketch the new face of systemic risk. After all, pre-Lehman, US banks’ compliance with the leverage ratio oiled the off-balance securitization engine, which found captive demand in Europe, given EU banks’ reliance on risk-weightings that fed their appetite for highly-rated securities.

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