Finance Watch welcomes the agreement of the Group of Central Bank Governors and Heads of Supervision of the Basel Committee on Banking Supervision (BCBS) to introduce the Basel III leverage ratio (LR) as a Pillar 1 measure by 1 January 2018.
The build-up of excessive leverage has proven to be one of the main threats to financial stability in 2007/08 crisis and many of the crises before. The leverage ratio has been identified as a significantly more reliable indicator of a bank’s distance to default than risk-based capital measures. It is also simple for banks to implement and more transparent for regulators to monitor and review. Finally, it is more responsive to cyclicality than RWA-based measures and hence a more effective tool to manage excessive credit creation during cyclical upturns.
- Finance Watch would like to reiterate its position that the Basel III regulatory framework should not rely on risk weighted assets (RWA) as its principal Pillar 1 indicator of capital. While we welcome the BCBS’s continued efforts towards reducing variation in RWAs, incremental improvements are still unlikely to remedy its fundamental shortcomings. We strongly support the view that the leverage ratio should be implemented as a primary capital measure, on a par with the RWA-based metrics, and construed as a binding constraint.
- The leverage ratio should be a simple, transparent and conservative measure that is complementary to, but separate from, the risk-based capital framework. We are therefore sceptical of proposals to expand the use of risk-based approaches for the calculation of certain elements of the leverage ratio exposure measure. In particular, we would prefer the Current Exposure Method (CEM) to be maintained for the calculation of counterparty credit risk exposure as it produces a more conservative measure of exposure than the Standardised Approach to Counterparty Credit Risk (SA-CCR), notably by excluding margining. Similarly, Credit Conversion Factors (CCFs), which capture off-balance sheet exposures, should still remain subject to a 10% risk-weighting floor.
- Finance Watch believes that the proposed calibration of the leverage ratio at 3.0% is not sufficient, neither as a backstop nor as a primary metric. At this level the leverage ratio would only constrain extreme outliers and become altogether meaningless as a regulatory benchmark. We strongly supports demands, supported by significant body of institutional research, to set the leverage ratio at a mandatory level of 4.0%, as a minimum. The need for a counter-cyclical adjustment to the leverage ratio, advocated by some to cushion the effect of banks deleveraging in a cyclical downturn, should also be reviewed.
- Finance Watch agrees with the BCBS’s suggestion that a higher minimum leverage ratio requirement could be appropriate to mirror the higher risk-based capital ratio requirements for global systemically important bank (G-SIBs). Certain jurisdictions, including Switzerland and the United States, have already introduced a higher Leverage Ratio of 5.0% for G SIBs, which we support. A higher leverage ratio requirement should also be incorporated into the corresponding framework for domestic systemically important banks (D-SIBs). The incremental Tier 1 capital used to cover any additional requirement should not be inferior to the quality of regulatory Tier 1 capital and should therefore be met with the same combination of CET1 and AT1 capital as the regulatory Tier 1 minimum (including buffers).
For further questions, please contact Christian M. Stiefmueller, senior policy analyst at Finance Watch.