The Unintended Consequences and Challenges of the Basel III Leverage Ratio: Supplementary Leverage Ratios

Abstract

The U.S standard leverage ratio, which is not as stringent as the U.S Supplementary Leverage Ratio, did not include Off Balance Sheet exposures - unlike the Basel leverage ratio. Hence the 3% Supplementary Leverage Ratio was established as part of measures to facilitate the inclusion of Off Balance Sheet exposures in July 2013 - even though many still consider the scope of such inclusion as not being extensive enough - since Secured Financing Transaction Exposures are still excluded. Furthermore, the Enhanced Supplementary Leverage Ratio increased the 3% leverage ratio to 5% (a 2% buffer) for globally systemic important banks (GSIBs) bank holding companies and 6 % for their banking subsidiaries. In respect of securities financing transaction exposures, however, U.S banks are considered to enjoy competitive advantage, since the exclusion of such exposures still persist - even though it is also argued that recent liquidity coverage and net stable funding ratio provisions should serve to address these exposures - this also being in line with the complementary functions of liquidity standards and leverage ratios within the risk-based capital adequacy framework. As well as contributing to the extant literature on supplementary leverage ratios, this paper will seek to illustrate why calibration between the risk capital adequacy framework, liquidity standards, and Basel leverage ratio is even more important than merely a focus on the relationship between the risk capital adequacy framework and the Basel leverage ratio. Meanwhile as regards Europe, there are also concerns relating to sovereign credit risks and the “inadequate pricing” of such risks which results in under capitalisation of banks, as well as potential consequences relating to serious distortions in financial stability whose effects could have repercussions extending beyond the Eurozone and globally. This paper considers two headings which have generated controversial discussions - particularly in respect of Basel III leverage ratio implementation, namely, under capitalisation of banks and the issue of calibration. It aims to illustrate why these constitute areas which are still in need of redress - even though tremendous efforts have been made to align the Basel III Leverage Ratio with the Supplementary Leverage Ratios. The paper will also demonstrate that whilst there are concerns related to the issue of calibration, certain jurisdictions such as the UK, have also introduced supplementary leverage ratios - as well as considered alternatives to the Basel leverage ratio.