Bank leverage ratio requirements in Basel
III could amplify risks in the financial system and fail the real economy,
according to a group of industry associations.
Five lobby groups, including the Global
Financial Markets Association (GFMA) and the International Swaps and
Derivatives Association (ISDA) have written to the Basel Committee on Banking
Supervision requesting changes to its proposed leverage ratio framework.
The letter forms part of the Basel
Committee’s public consultation on leverage ratios in Basel III.
In it, the associations said they are
concerned that the proposed framework’s methodologies would significantly
overstate actual economic exposure of banks. They believe this form of measurement
will result in the leverage ratio, rather than risk-based capital ratio,
becoming the binding capital measure for a significantly number of banks.
While the risk-based capital measure takes
into account how risky an asset is when assessing a bank’s capital
requirements, the leverage ratio does not.
The associations believe this will require
banks to hold much higher capital for their least risky assets such as cash and
highly liquid government securities.
“This would create a perverse incentive to
reduce such assets and the activities that generate such assets,” the letter
said. “For example, the demand for high-quality sovereign debt would be
reduced, thereby constricting liquidity, increasing volatility in the markets
for such debt, and increasing the cost of government borrowing.”
If banks were to face a binding leverage
ratio then they would also see a reduction in demand for low-risk debt, cutting
lines of credit that are needed to support economic growth.
One example highlighted by the associations
is the reverse repo market, where a typical agreement would require a 50 basis
point spread simply to equal the cost of capital. By comparison, a similar
transaction today would need a spread of 5 basis points. There is concern that
this will not be economically viable for the banks, and as such most will
reduce their participation in the securities financing market.
The associations have recommended a range
of modifications to the Basel Committee, including excluding cash claims on
central banks from its exposure measurements, as well as excluding several very
low risk assets. By not including these assets in the leverage ratio, there
would be less incentive for banks to push them out of their portfolios in
favour of high-yield, high-risk instruments.
It said there should at least be partial
exclusions on the above based on their relative levels of liquidity in order to
ensure the securities financing market is able to continue functioning.
However, the associations said the Basel
Committee should work to ensure that risk-based requirements are the key
measure of a banks capital.
“The Committee should reinforce the
longstanding principle that the risk- based requirements should be the binding
measure and the leverage ratio the backstop measure for internationally active
institutions subject to the Basel standards,” they added.