A material element of the Basel III package and its implementation in the EU is the introduction of a leverage ratio, which currently reflects an institutions's tier 1 capital (the numerator) over total exposure (the denominator). Therefore, an institution with a high level of leverage will have a low leverage ratio as defined by the fraction of capital and the exposure measure. The balance sheet valuations refer to the relevant accounting standard applicable to the institution. In order to make the leverage ratio internationally comparable, some special adjustments have been provided for.
In line with international agreements, the leverage ratio was introduced first as an additional feature that can be applied on individual institutions at the discretion of supervisory authorities (pillar 2). In the meantime, a minimum requirement of 3% for the leverage ratio is tested (pillar 1).
Unlike the risk-based capital requirements, which could also be based on model assumptions, for the leverage ratio the individual exposures are not risk-weighted but instead included in the metric value unweighted. The leverage ratio is designed to address regulatory weaknesses which were revealed during the crisis. Not only should the leverage ratio counteract the fundamentally cyclical effect of risk-based capital requirements but, as a supplementary risk-insensitive instrument, offset the deficits of risk-based capital requirements (known as a backstop function). Such flaws were exposed in the crisis when banks' losses, in some cases, significantly exceeded the risks calculated with the aid of models.
As it applies for all Member States, the CRR, amended by a Commission Delegated Regulation, is the legal basis of the leverage ratio requirements in Germany. The scope of application, however, was expanded to a broader definition of the term "institution", comprising, for example, institutions which only take deposits but do not grant credits (§ 1a German Banking Act).
In order to assess the risk of excessive leverage, institutions have to report all necessary information on the leverage ratio and its components to the competent authorities, with a quarterly frequency. Furthermore, since 2015 all institutions are required to disclose their leverage ratio and its components.
During an observation period, supervisors will track the new ratio in order to analyse its impact more closely (cf. Basel III monitoring), with a view to complete possible adjustments to the definition by 2017. Moreover, the observation period will be followed by a decision on whether to set a binding minimum requirement for the leverage ratio at the European level starting 2018, and, if so, how high the requirement should be.