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Brussels, 10 October 2014
Leverage Ratio Delegated Act: Frequently Asked Questions
See also IP/14/1119
1. What is the leverage ratio?
The leverage ratio is defined as Tier 1 capital divided by a non-risk-based measure of an institution’s on- and off-balance sheet items (the “exposure measure”).
2. Why do we need to address leverage in the banking sector?
Leverage is an inherent part of banking activity; as soon as an entity's assets exceed its capital base it is leveraged. However, the financial crisis highlighted that credit institutions and investment firms were highly leveraged, i.e. the sum of their assets and off-balance sheet items was sometimes more than 40 times higher than the amount of their capital.
3. What purpose does the leverage ratio serve?
The leverage ratio has two objectives: first to limit the risk of excessive leverage by constraining the building up of leverage in the banking sector during economic upswings and second to act as a simple instrument that offers a safeguard against the risks associated with the risk models underpinning risk weighted assets (e.g. that the model is flawed). The ultimate aim is also to constrain leverage and to bring institutions' assets more in line with their capital in order to help mitigate destabilising deleveraging processes in downturn situations.
4. Why is the Commission adopting this delegated act?
The co-legislators empowered the Commission to amend the capital measure and total exposure measure of the leverage ratio through a delegated act if the reporting to competent authorities uncovered shortcomings in the way those measures are currently defined. This was to be done before the date from which institutions must start disclosing the leverage ratio (i.e. prior to 1 January 2015). The European Banking Authority (EBA) informed the Commission that there are significant differences in how institutions in different Member States understand and interpret the existing rules on the leverage ratio. Based on the EBA’s analysis, the Commission considers that these differences would result in significant differences in the way the leverage ratio is calculated. This would in turn lead to a situation where the numbers disclosed by different institutions would not be comparable throughout the Union.
5. Is this delegated act based on a draft by the European Banking Authority?
No, the co-legislators decided that this delegated act should be drafted entirely under the responsibility of the Commission. The EBA has no role in its preparation. The EBA is, however, involved in drafting about 118 regulatory technical standards (RTS) and implementing technical standards (ITS) for the Capital Requirements Regulation (CRR) and Capital Requirements Directive (CRD IV) (see MEMO/13/690).
6. Will the leverage ratio defined by the delegated act differ from the internationally agreed Basel III leverage ratio?
No. The text faithfully implements the Basel revised rules text as agreed by the GHOS (Governors of Central banks and heads of supervision of Basel Committee member jurisdictions). This is important because the leverage ratio which will have to be disclosed from 1 Jan 2015 onwards should be comparable internationally.
7. What are the main changes compared to the current Capital Requirements Regulation definition of the leverage ratio?
The delegated act introduces the following overall changes compared to the current text:
1. The calculation and reporting period is defined as at the end of the reporting period (quarter) instead of a three-month average. This amendment not only reduces the operational burden for institutions but also aligns the leverage ratio with the solvency reporting data to which it should act as a backstop.
2. The scope of consolidation will be the regulatory scope of consolidation used for the risk-based framework instead of the accounting scope of consolidation. This is more practical and better aligned with the risk-weighted solvency requirements.
3. A clarification that for securities financing transactions (SFTs) such as repurchase agreements (repos), collateral received cannot be used to reduce the exposure value of said SFTs but that cash receivables and payables of SFTs with the same counterparty can be netted, subject to strict criteria.
More technical changes include:
1. Using the credit risk conversion factors of the standardised approach for credit risks, subject to a floor of 10%, instead of the 100% weighting of off-balance sheet exposures.
2. For derivatives, the cash variation margin received can be deducted from the exposure value when meeting strict conditions.
3. Written credit derivatives are measured at their gross notional amount instead of at their fair value, but fair value offsetting of protection sold with protection bought is allowed, subject to strict criteria.
8. Will the delegated act require banks to meet a minimum leverage ratio requirement?
No. The empowerment for the delegated act was limited to changes in the calculation of the capital measure and exposure measure of the leverage ratio.
9. Which requirements related to the leverage ratio are currently in CRDIV/CRR?
Since the leverage ratio is a new regulatory tool in the EU, there is a lack of information about the effectiveness and the consequences of implementing it as a binding (Pillar 1) measure. It is therefore important to gather more information before making it a binding requirement. The current leverage ratio regime includes:
10. Would European banks meet an indicative 3% Tier 1 leverage ratio?
Yes. European banks are on average well above a 3% Tier 1 leverage ratio based on fully-transitioned Basel III standards (which will apply from 1 January 2019 onwards). According to the EBA’s recent report monitoring the impact of Basel III, larger banks (with capital of 3 billion euro or more) have an average leverage ratio of 3.7% and smaller banks 4.5%. These ratios reflect significantly improved capital positions of European banks compared to the pre-crisis situation.
11. What is the consequence of the changes for supervisory reporting and disclosure?
The delegated act will amend the calculation of the leverage ratio compared to the current text of the CRR and therefore corresponding changes to the supervisory reporting on the leverage need to be made. So the EBA will have to submit an amendment to the Implementing Technical Standard (ITS) on supervisory reporting to align the supervisory reporting with the amended definition. Furthermore, the EBA will also have to re-submit the ITS with the disclosure template for adoption by the Commission.
12. What process did the Commission follow in preparing this act?
On 10 March 2014, the Commission organised a public hearing with stakeholders. Subsequently the Commission received about 60 written comment letters and contributions, most of which came from banks and business associations. The vast majority of respondents were supportive of the leverage ratio as a supplementary backstop to the risk-based capital measure. Comments from stakeholders were addressed, in particular as regards the recognition of cash variation margins in other currencies insofar as these are included in the master netting agreement and the exclusion of intra-group exposures when the leverage ratio is applied at individual level. The latter is particularly important for cooperative banking groups with many individual entities.
The European Banking Authority (EBA) performed an in-depth impact assessment of the leverage ratio rules. This was in addition to the impact assessment that was published alongside the CRR proposal on 20 July 2011 on the impact of introducing leverage ratio-related rules. The EBA assessed data provided by approximately 170 banks from 18 Member States and showed that, on average, European banks would meet an indicative 3% Tier 1 leverage ratio so that public disclosure from 2015 would not create a sudden recapitalisation need.
13. How do the new rules address concerns that the introduction of the leverage ratio would have significant negative impacts, including on trade finance and on lending to small and medium-sized enterprises?
There is not currently sufficient information to estimate the precise impact of the leverage ratio. That is why the leverage ratio was not introduced outright as a binding measure, but rather as a Pillar 2 measure (i.e. the judgement on whether or not the leverage ratio of a particular institution is too high and whether that institution should hold more capital as a consequence will be left to the supervisor of that institution).
In accordance with the CRR, the European Commission is required to submit, by the end of 2016, a report on the leverage ratio to the Council and the Parliament. The report will be based on an EBA report and will be accompanied, where appropriate, by a legislative proposal to introduce a binding leverage ratio or different leverage ratios for different business models, applicable from 1 January 2018 onwards. During the observation period until mid-2016, the EBA will gather and analyse the necessary data and review the impact of the leverage ratio.
14. How do the new rules take into account various business models throughout the Union, including low-risk types of business profile?
The review of the leverage ratio will include the identification of institutions’ business models and whether the level of the leverage ratio should be the same for all types of business model. If deemed appropriate, several levels of leverage ratio may be introduced in order to reflect the overall risk profile, the business model and size of institutions.