Leverage Ratio

One of the major elements of the Basel III framework and its implementation in the European Union (EU) is a leverage ratio. This sets a bank’s supervisory Tier 1 capital (numerator) in relation to its (on-balance and off-balance sheet) total exposure (denominator). Calculated this way, a low leverage ratio indicates that a bank has a high level of debt in relation to its Tier 1 capital. Valuations of balance sheet items for the purposes of calculating this ratio generally follow the relevant accounting standard applicable to the institution in question. Some special provisions have been included, however, to ensure comparable leverage ratios across jurisdictions.

Unlike the procedure for risk-based capital requirements, which are also based on model assumptions, individual exposures are generally not individually risk-weighted for the purposes of calculating the leverage ratio but are instead included in the exposure measure unweighted. The leverage ratio is designed to address regulatory shortcomings that surfaced during the financial crisis, beginning in 2007. Its aim is, inter alia, to counteract the fundamentally cyclical effect of risk-based capital requirements and, as a supplementary, to ensure a minimum level of capital (backstop function). 

The leverage ratio was introduced initially as a supplementary instrument that could be applied to individual institutions at the discretion of supervisory authorities (Pillar II). In December 2017, the Basel Committee on Banking Supervision (BCBS) then decided to set the provisional 3.0% target ratio as a binding minimum requirement (Pillar I) as of 2018.

In addition to the leverage ratio’s shift to a Pillar I requirement under the three-pillar model of prudential supervision, the finalised Basel leverage ratio framework introduced various technical changes to the methodology for calculating the ratio. Furthermore, for global systemically important banks (G-SIBs) the leverage ratio requirements have been increased since 2023 by a capital add-on, which is also composed of supervisory Tier 1 capital, and amounts to 50% of the risk-based capital buffer for G-SIBs. For example, a bank required to hold a risk-based G-SIB buffer of 2% is subject to an increase of the general leverage ratio requirement by one percentage point to a total of 4%.

For the EU Member States, the Capital Requirements Regulation (CRR, Regulation (EU) No 575/2013) in its applicable version forms the legal basis for the leverage ratio requirements. Nationally, its scope was widened by the introduction of a broader definition of the term “institution”, however. For example, this definition also covers institutions that only take deposits and do not grant loans (Section 1a of the German Banking Act, Kreditwesengesetz).

To enable the risk of excessive leverage to be assessed, institutions report all the necessary information relating to the leverage ratio and its components to the national competent authorities on a quarterly basis. In addition, since 2015, institutions have been obliged to publicly disclose their leverage ratio and its components. With the application of the CRR II package, the leverage ratio became a binding minimum requirement within the EU as of June 2021. With the introduction of CRR II, the capital add-on for G-SIBs in the EU was also implemented in accordance with the Basel Committee’s requirements as of 2023. Similar to the risk-based framework, the competent authority can set an additional capital requirement (Pillar 2 Requirement – P2R-LR) and/or an additional capital guidance (Pillar 2 Guidance – P2G-LR) for the leverage ratio on an institution-specific basis as part of the Supervisory Review and Evaluation Process (SREP).