EBA recommends introducing the Leverage Ratio in the EU

The European Banking Authority (EBA) published today its report on the impact assessment and calibration of the Leverage Ratio (LR), recommending the introduction of a LR minimum requirement in the EU to mitigate the risk of excessive leverage. The analysis suggests that the potential impact of introducing a LR requirement of 3% on the provision of financing by credit institutions would be relatively moderate, while, overall, it should lead to more stable credit institutions. The report will inform the work of the European Commission on potential legislative proposals on LR.

The EBA report recommends the introduction of a minimum LR requirement in the EU to mitigate the risk of excessive leverage, which is in line with the discussions held by the Group of Central Bank Governors and Heads of Supervision (GHOS) in January 2016.

The results of the quantitative analyses performed suggest that a 3% level of calibration for the LR is generally consistent with the objective of a backstop measure which supplements risk-based capital requirements. At the same time, the results of a simulation-based analysis estimating the impact of potential adjustment actions firms that do not meet the leverage ratio might take, suggest a high sensitivity to changes in the calibration of the LR and estimate that the potential reduction of exposures would increase significantly beyond a LR level of 3.5%.

The potential impact of introducing a LR requirement of 3% on the provision of financing by credit institutions would be relatively moderate. Similarly, on the basis of econometric analysis, it has been estimated that risk taking should not be strongly affected. The introduction of a 3% LR should lead to more stable credit institutions overall and the combined application of a risk-based ratio and a LR requirement will reduce the overall cyclicality of capital requirements.

Furthermore, considering possible differentiation of the LR by business models, size or systemic relevance, the EBA has assessed the exposure of different categories of credit institutions to the risk of excessive leverage (REL) by means of a quantitative benchmarking, complemented by a qualitative judgment. Overall, the results do not give a strong indication of differences in the degree of exposure to REL across different types of credit institutions. However, global systemically important institutions (GSIIs) show a higher exposure to REL and therefore a higher LR requirement may be warranted.

The report also flags that while the Basel LR standard is fitting well with the EU banking sector, the specificities of certain business models already covered by other EU prudential regulations should be taken into account. This is particularly the case for Central Counterparties (CCPs) and Central Securities Depositaries (CSDs), which the EBA recommends be exempted. More broadly, the report describes the characteristics of various specialised business models, such as public development banks, and concludes that there is little room for differentiating the LR without opening at the same time the door to a potential circumvention of the basic principles of the LR.

The EBA report did not find arguments to exempt certain credit institutions from being subject to compliance with a 3% LR minimum requirement on the basis of their limited size. However, the EBA will specifically explore more in detail a reduced frequency and/ or granularity of reporting requirements in future updates of the Implementing Technical Standard (ITS) on LR reporting.

Finally, the report included input from the European Systemic Risk Board with regard to the potential impact of a LR on market liquidity.

The EBA statement together with the report is available here.

Lavanya Rathnam

Lavanya Rathnam is an experienced technology, finance, and compliance writer. She combines her keen understanding of regulatory frameworks and industry best practices with exemplary writing skills to communicate complex concepts of Governance, Risk, and Compliance (GRC) in clear and accessible language. Lavanya specializes in creating informative and engaging content that educates and empowers readers to make informed decisions. She also works with different companies in the Web 3.0, blockchain, fintech, and EV industries to assess their products’ compliance with evolving regulations and standards.

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