Enhanced Leverage Ratios For UK Financial Institutions

Author:Shearman & Sterling LLP
Profession:Shearman & Sterling LLP
 
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The Financial Policy Committee of the Bank of England recently issued recommendations for enhanced leverage ratio requirements to apply to UK global systematically important banks, and other major domestic UK banks and building societies. HM Treasury has accepted these recommendations and will exercise its powers to enable the Financial Policy Committee to direct stricter leverage requirements for such UK institutions.

Introduction

The leverage ratio was introduced as an essential pillar of the Basel III Accord. It backstops the risk-weighted capital requirements for credit exposures and provides a capital floor that mitigates the variations in the way different banks risk-weight their exposures. A minimum leverage ratio of 3%, which is now the internationally agreed standard, has been the subject of individual national add-ons, particularly for global systemically important banks ("G-SIBs").1 For example, in the US G-SIBs will be subject to a supplementary ratio which means that the overall leverage ratio requirement in the US for those institutions is to be 5%.2

In line with this increasingly prevalent trend to tighten the internationally agreed minimum standard, HM Treasury tasked the Financial Policy Committee of the Bank of England (the "FPC") to review and recommend an appropriately calibrated leverage ratio framework for UK firms. The FPC has recently completed its review3 and has recommended to the appropriate leverage standard for UK banks, building societies and significant investment firms regulated by the Prudential Regulation Authority (the "PRA").

The FPC makes three main recommendations:

early implementation of the 3% minimum leverage ratio requirement for all banks, building societies and PRA-regulated investment firms; a supplementary leverage ratio buffer set at a rate of 35% of the systemic risk-weighted buffer for UK G-SIBs and other major UK banks and building societies; and a countercyclical leverage ratio buffer for all banks, building societies and PRA-regulated investment firms set at 35% of the countercyclical capital buffer that may be imposed. HM Treasury has accepted the FPC's proposals and will set out legislation for the FPC to be given these powers of direction. A further difference from the Basel standard is that at least 75% of the minimum 3% core leverage ratio requirement is required to be met using Common Equity Tier 1 capital. This may be adjusted following any review to reflect any further...

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