UK Leverage Ratio Requirement: A Cornucopia Of Capital Complexity?

Author:Mr Simon Brennan and Kateryna Bobrova

The Bank of England Financial Policy Committee's (FPC) recently published review on the role of the leverage ratio in the UK proposes moving ahead of international standards to introduce new requirements for the biggest UK banks and building societies from next year. It recommends those banks eventually meet a 'static' requirement of up to around 4% on an ongoing basis (comprising a minimum of 3% and a supplementary buffer capturing systemic risk). There would also be a time-varying component that varies with the credit cycle and could add around 90 basis points more for some banks at the top of the cycle (on the FPC's current assumptions).

Calibration, complexity and risk-sensitivity were important topics of debate in advance of the report. The fixed part of the requirement came out close to most industry expectations, although considerably lower than some. The overall package is simpler than in the previous consultation, although it remains more complex than some would have liked. The FPC highlighted that 3% leverage is consistent with the minimum Tier 1 risk-weighted capital required against mortgage lending under the Basel Standardised Approach, so as not to disincentivise banks and building societies from (new) mortgage lending.

The government will now lay legislation before Parliament to effect the recommendations (giving the FPC the power to direct the Prudential Regulation Authority (PRA)). Once approved, the minimum requirement of 3% will be applied straightaway for the largest banks and building societies (superseding the current supervisory expectation that these firms meet a 3% minimum). Buffers within the ratio will be implemented subsequently. Other PRA-regulated firms will be required to meet the 3% minimum from 2018.

UK leverage ratio: simples

The complexity of the proposed leverage ratio framework is borne out of symmetry with the risk-weighted framework, which the FPC argues is required to maintain the relationship with the risk-weighted ratio (and therefore its effectiveness). The ratio will comprise:

A minimum requirement of 3%, for all PRA-regulated firms. A supplementary leverage ratio buffer (SLRB) for UK G-SIBs, ring-fenced banks and large building societies. The G-SIBs buffer will be set at 35% of the risk-weighted systemic risk buffer and will be phased in from 2016. The appropriate calibration of the buffer for the other firms will be reviewed next year and will apply from 2019. A countercyclical leverage ratio...

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