Thursday, April 7, 2016

Basel Committee Consults on Softening Leverage Ratio

Proposes Changes to the Calculation and Overall Leverage Limits

Author: David Schwartz J.D. CPA

On March 6, 2016, the Basel Committee on Banking Supervision (BIS) published a consultation paper proposing to amend or “calibrate” the Basel III non-risk-based leverage ratio. Banks have been lobbying the Committee quite aggressively to make changes to the way the leverage ratio leverage ratio is calculated to alter the ratio’s overly rigid approach, which they say ignores or fails to take into account the way banks handle transactions in derivatives in practice.  This consultation proposes some softening of the rules by which banks that trade large numbers of financial derivatives calculate their leverage ratios.  In addition, the consultation seeks comment on potentially raising the leverage ratio limit above 3% for certain global systemically important banks (G-SIBS) like Goldman Sachs, Societe Generale, Morgan Stanley and HSBC, while leaving it the same for other banks.  


In terms of the leverage ratio, the March 6 consultation aims to address netting of derivatives exposures in the calculation of the ratios for banks engaged in large-scale derivatives transactions. Typically, in clearing these transactions, banks are required to post a margin or cash to cover risks of losses. For purposes of calculating the leverage ratio, banks would like to be allowed to deduct their posted margins from their derivatives exposures to leave a net figure that would not require reserving additional capital.  The consultation seeks comment on what the Committee calls a "standardized approach" for measuring counterparty credit risk, which would allow some netting of these kinds of trades; however, the consultation document seeks more evidence on whether to allow banks to cut exposures further by taking into account customer margins.  Presumably, based on the input received on this consultation, coupled with a planned BIS quantitative study, the final rules will either force banks to count derivatives exposures for purposes of the leverage ratio on a gross basis until the trades are settled as under the current methodology, or allow banks to include trades before settlement on a net basis as banks have been lobbying for.  Either way, BIS is seeking uniformity of treatment globally. 


As far as raising the leverage ratio for G-SIBs, the consultation seeks input on factors that should be considered should the leverage ratio limit be raised for G-SIBs.  The Committee said the top leverage ratio limit could be a fixed number applied to all 30 banks uniformly, or the limit could vary by bank in the same way as the capital “surcharge."


Comments on the consultation are due by July 6, 2016.