As you may be aware, the Basel Committee finalised the leverage ratio framework and accompanying disclosure framework earlier in 2014, and the European Commission has issued a detailed Delegated Regulation amending the Capital Requirements Regulation (CRR) regarding the implementation of the leverage ratio within Europe, which sets out the EU-wide application of the leverage ratio from 1 January 2018 (see Edition 12  of this SCM Briefing for a detailed summary). As mentioned, the precise level of the Basel Committee's leverage ratio (proposed at 3%) is not yet set in stone, and the European Commission will agree on the figure for the EU-wide ratio at the end of 2016. The Bank of England's Financial Policy Committee (FPC) was widely expected to set a higher ratio when it realised its own leverage ratio framework, and the FPC has now published the Financial Policy Committee's Review of the Leverage Ratio, which sets out the FPC's final recommendations on the final leverage ratio framework that will apply to UK banks, and its calibration. There are three elements to the FPC's leverage ratio framework, which combined, deliver the appropriate calibration:

  • The minimum leverage ratio requirement: the minimum leverage ratio requirement would be set at 3%, which is consistent with domestic and international loss experience during historical banking crises. This would require banks to hold £1 of capital for every £33 they lend out, on a very simple calculation (i.e. capital divided by exposures = minimum 3%). However, the FPC notes that the leverage ratio could practically rise up to 4.05%, and up to as much as 4.95% by 2019, depending on whether the full buffers are added on over time (see below). However, the market has expressed some relief that the FPC has not gone beyond the Basel III suggested 3% level for the leverage ratio.

  • A supplementary leverage ratio buffer: that will apply to global systemically important banks (G-SIBs) and other major domestic UK banks and building societies, including ring-fenced banks, whose failure would be most destabilising for the UK financial system. This would be set at 35% of the corresponding risk-weighted systemic buffer rates for these firms (as you may be aware, the systemic risk buffer (SRB) is a temporary, CRD IV-specific buffer that will be used on a discretionary basis in circumstances in which excess credit growth needs preventing, such as another housing bubble, but it is currently set at 0% in the UK) and will be implemented from 2016.

  • A countercyclical leverage ratio buffer (CCLB): to be applied by all Prudential Regulation Authority (PRA)-regulated banks, building societies and investment firms, to address risks arising during the cycle. To be raised in response to risks to financial stability, the CCLB rate would be set at 35% of the risk-weighted countercyclical capital buffer (CCB) (the "simplest" of the Basel III/CRD IV buffers, the CCB must be held in the form of common equity to provide a 'buffer' of capital that can absorb losses during future periods of stress, and is set at a rate of 0-2.5% of risk-weighted assets). Changes to CCLB rates would be implemented at the same time as changes to CCB rates, to ensure consistency.

The denominator of the leverage ratio would be aligned with the Basel III definition (the "exposure measure", which was set out in the European Commission's Delegated Act on the Leverage Ratio - see our summary in Edition 12, which confirmed that the (EU-wide) exposure measure would be amended slightly to incorporate assets, derivatives, certain add-ons and certain off-balance sheet items as set out in paras 5, 9 and 10 of the Delegated Act and Article 429b of the CRR). The numerator (the capital resources measure) is slightly differently calculated, with certain Additional Tier 1 (AT1) capital instruments permitted to comprise up to 25% of the minimum requirement, such that the numerator comprises Common Equity Tier 1 (CET1) capital, plus AT1 (up to 25%). However, buffers would have to be met by CET1 only. What is clear is that, while banks will be subject to a minimum 3% leverage ratio, its precise calibration for each individual bank will depend on several factors, including the bank's size and the relative state of the UK economy, meaning that the specific rate to be met by each institution is different and can vary over time.

The FPC's leverage ratio framework will take effect in line with the Basel III leverage ratio requirements which are to be applied from 1 January 2018, but the UK framework will be reviewed in 2017 to assess progress on finalising the international standards (and establishing the final, Basel III leverage ratio rate) and may be amended at that time. Legislation may be issued to implement the leverage ratio framework, and the FPC will publish a draft Policy Statement in early 2015 if this is the case. The FPC's recommended leverage ratio framework must now be reviewed and approved by the UK Chancellor, and further work undertaken to provide the FPC and the PRA with the necessary tools to administer the leverage ratio framework (and the related aspects, such as the CCB and SRB frameworks).

Useful links:

Bank of England: The Financial Policy Committee's Review of the Leverage Ratio
European Commission Delegated Regulation amending the Capital Requirements Regulation (CRR) regarding the implementation of the leverage ratio