Basel III Capital Requirements Face Dilution

Revised bank leverage-ratio plan is expected to be less strict, reducing the likelihood that new capital requirements will severely curtail lending.

Lenders are poised to win concessions from central bank chiefs and global regulators over a debt limit they criticized as a blunt instrument that would penalize low-risk activities and curtail lending.

A revised leverage-ratio plan is set to be laxer than a draft published last year by the Basel Committee on Banking Supervision, said a person familiar with the scope of a Jan. 12 meeting of the group’s oversight body at which the measure will be discussed.

Leverage ratios are designed to curb banks’ reliance on debt by setting a minimum standard for how much capital they must hold as a percentage of all assets on their books. A quarter of large global lenders would have failed to meet the draft version of the leverage limit had it been in force at the end of 2012, according to data published by the committee in September.

“I expect considerable change in the rule to defer to applicable national accounting systems,” Karen Shaw Petrou, managing partner of Washington-based research firm Federal Financial Analytics Inc., said in an e-mail. “If the rule in fact doesn’t do this, it will wreak tremendous havoc in securities financing, repo, and other capital-market activities and send them over to the shadows.”

Some supervisors have called for greater use of leverage ratios instead of standard Basel capital requirements, which are measured as a ratio of banks’ equity against risk-weighted assets, because banks are inconsistent in the way they calculate these standards.

The draft leverage rule published last year would have required banks to hold capital equivalent to at least 3 percent of their assets, without any possibility to take into account the riskiness of their investments. Stefan Ingves, the Basel committee’s chairman, has said that discussions in the group have focused on calibrating how banks should calculate the size of their assets, as opposed to reopening talks on the 3 percent figure.

“In our view, the final leverage rule will be significantly moderated to avoid it becoming a binding constraint on bank lending activity,” research firm Capital Alpha Partners LLC wrote in a note to clients yesterday.

The “most likely adjustments will be to allow for greater netting for derivatives and securities financing transactions,” according to the note. There is also “a good chance” that regulators will scale back rules on how banks must calculate the size of some off balance sheet commitments, it said.


Stated Intentions

The Basel committee declined to comment on the leverage ratio talks.

“Overall, and in contrast to publicly stated intentions, a binding leverage ratio may actually encourage increased risk-taking by European banks while at the same time forcing them to cut back on low-risk exposures” such as derivatives used to hedge risk, Jan Schildbach, senior economist at Deutsche Bank Research, said in an e-mail. This would potentially hurt “their clients and the European economy as a whole.”

Global regulators have met for almost 40 years in Basel, Switzerland, to negotiate common standards for supervising the banking system.

The Jan. 12 meeting will be of the Group of Governors and Heads of Supervision, or GHOS, which oversees the committee’s work and is comprised of central bank and regulatory chiefs. The GHOS is led by Mario Draghi, the president of the European Central Bank.

Relying on leverage ratios to assess a bank’s strength wouldn’t be sensible, as the measure can easily be influenced and is hard to compare between lenders under different reporting standards, Rabobank Groep Chief Financial Officer Bert Bruggink said in an interview this week.

“For banks reporting under European accounting rules, a leverage ratio of 3 percent or 4 percent is very well defendable,” Bruggink said. “Requiring higher numbers, especially if that’s done with reference to U.S. banks, would be wrong and harmful to the economy.”


The Main Item

The leverage measure is the main item on the agenda for the GHOS talks, according to two other people familiar with the talks. All three asked not to be identified because the discussions are private.

Under the published Basel timetable, banks will be expected to publicly disclose how well they measure up to the standard from 2015, with the rule to become a binding minimum standard in 2018.

Banks such as BNP Paribas SA, Bank of America Corp. and Citigroup Inc. have called for a rewrite of the draft leverage rule published in June, saying it would adversely affect economic growth and job creation, make it more expensive for governments to sell their debt and give banks incentives to invest in riskier assets.

“The leverage ratio instrument sets the wrong incentives by discriminating against low-risk business, which also accounts for a larger share of European banks’ operations than for U.S. institutions,” Schildbach said. “In addition, in the U.S., a compulsory leverage ratio has been in place for many years already, whereas the Europeans are used to align their business models to a system of risk-weighted capital ratios.”


More Scope

Banks have called on the committee to alter the rule by giving lenders more scope to carry out netting, which would allow them to reduce the size of the pool of assets used to calculate the leverage ratio.

Netting is an accounting term describing the process of banks offsetting the value of different assets and liabilities they have taken on with a single counterparty.

Lenders have argued that they should be allowed to net the collateral received on derivatives trades, because otherwise the protection they gain wouldn’t be taken into account by the leverage ratio. They have also called for more scope to use netting on securities financing transactions such as repurchase agreements, or repos.

Other requests from banks have included that assets perceived to bear little risk of loss, such as high-quality mortgage debt, should be exempted or partially exempted from the leverage ratio calculation.

Knowing how the international leverage ratio is defined “is important domestically for a level playing field,” Bank of England Governor Mark Carney told U.K. lawmakers in November, according to a public record of the proceedings.

“My personal view is that a leverage ratio is an integral part of the capital framework of banks, so it is absolutely necessary,” Carney said.

There is no chance that all high-quality assets will be removed from the calculations, Simon Hills, executive director at the British Bankers’ Association, said in a telephone interview.

“The most we can probably hope for on scope is a little movement,” he said. “Our priority is that cash held with central banks should be excluded from the leverage ratio calculations, as well as gilt purchases made as part of central bank monetary policy operations. We think that merits another look.”

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