The challenges of the leverage ratio

Simon Samuels

Journal of Risk Management in Financial Institutions, 2014, vol. 7, issue 3, 231-238

Abstract: The crisis of confidence in the risk-weighted asset (RWA)-based capital ratios has seen regulators increasingly embrace the non-risk weighted ‘leverage ratio’ for measuring capital adequacy. While such ratios have the apparent virtue of simplicity, debates over the definition of assets in practice make the leverage ratio a far from simple measure. Moreover, the initial Basel III idea of the leverage ratio being little more than a ‘back stop’ measure appears to have been overtaken by its promotion to Pillar I status, thus ranking it as the equivalent to the RWA measures. For European banks in particular — who unlike US banks have not developed the necessary financial architecture to cope with a leverage ratio — this represents a major challenge, disrupting the economics of different business activities. Rather than the current unappealing choice of following either a not-trusted internal ratings-based measure or an ultra-crude leverage measure, a better option might be standardised RWAs.

Keywords: leverage; Capital Requirements Directive (CRD) IV; Basel III; divisional profitability; back stop vs front stop; financial architecture; standardised RWAs (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:aza:rmfi00:y:2014:v:7:i:3:p:231-238

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