Economic Commentaries: The leverage ratio – what is it and do we need it?

Date 26/06/2013

Excessive leverage is a common denominator in most economic crises. Despite this, there are no direct restrictions in the regulatory framework as to how much leverage banks can take on. During the years prior to the crisis, for instance, many banks were able to expand their operations substantially using debt financing, while showing good capital adequacy. To reduce the risks linked to excessive leverage, the Basel Committee for Banking Supervision, which is responsible for drawing up international recommendations on banking standards, has agreed to introduce a new capital adequacy requirement – a leverage ratio. This aims to set a limit on the amount of debt banks can use to finance their operations, regardless of the risk their activities are considered to entail.

 

This Economic Commentary explains what the leverage ratio entails and shows that it can be a good complement to the traditional capital adequacy requirement. The Swedish banks already meet the proposed leverage ratio requirement, even though, on average, they are slightly below the international average of 3.8 per cent. However, the details of the regulation are yet to be decided. Today the Basel Committee published a consultative document today on a proposed design of the leverage ratio.

 

Read the whole Economic Commentary.