Further clarity on leverage ratio requirements for European banks

Transcription

1 25 April 2016 Financial Institutions Further clarity on leverage ratio requirements for European Further clarity on leverage ratio requirements for European On 15 April 2016, the EBA presented its draft report on the calibration of the leverage ratio under Article 511(3) of CRR. We review the status of leverage ratio implementation and consider where future requirements may end up, particularly for European global systemically important (G-SIBs). In Europe, the leverage ratio has been part of the Supervisory Review and Evaluation Process (SREP), therefore under Pillar 2, since CRD IV clarifies that should effectively manage the risk of excessive leverage referring to risks resulting from an institution's vulnerability due to leverage that may require unintended corrective measures, including the distressed selling of assets which might result in losses or in valuation adjustments to remaining assets. CRR requires to compute a leverage ratio, report it to their supervisors and from January 2015 to disclose it publicly. Analyst Pauline Lambert p.lambert@scoperatings.com The EBA has been mandated to report on various aspects of the leverage ratio including (i) whether the leverage ratio should migrate to Pillar 1 and if so what the minimum level(s) should be taking into account business models and risk profiles; (ii) the interaction between the leverage ratio and RWA-based ratios and liquidity requirements as well as the impact on various segments of financial markets; and (iii) whether the leverage ratio is an appropriate tool for managing the risk of excessive leverage. Based on the results of its quantitative analysis, the EBA concluded that a 3% leverage ratio is generally consistent with the objective of a backstop measure which supplements risk-based capital requirements. Further, the potential impact of introducing a 3% leverage ratio requirement on the provision of financing by credit institutions is relatively moderate when put into the context of the overall size of the banking sector. For a sample of 246 entities across 20 countries the weighted average leverage ratio was 4.4%. In the public hearing mentioned above the EBA highlighted that its work was probably most useful for future supervisory practices. The EBA recognised the challenges in light of varying business models and risk profiles and that there may be unintended consequences in specific cases. It cautioned, however, that it would be difficult to design differentiated requirements without defeating the original purpose of the leverage ratio. By year-end 2016, the European Commission, considering the EBA s report on the impact and effectiveness of the leverage ratio, will present where appropriate a legislative proposal to introduce a Pillar 1 leverage ratio, with suitable level(s). In our view, there appears to be a good likelihood that systemically important in the EU will be subject to additional requirements, as is already the case in the EU for the UK and outside the EU for Switzerland and the US. Scope Ratings AG Suite Angel Square London EC1V 1NY Phone Headquarters Lennéstraße Berlin Phone Fax Service info@scoperatings.com Bloomberg: SCOP 25 April /6

2 Figure 1: Compliance by business model Preliminary conclusions from EBA draft report The EBA performed analysis on a sample of 246 credit institutions from 20 countries with June 2015 as a last reference date with data coming from the EU Voluntary QIS exercise. Institution-specific balance sheet data was used rather than aggregate data for assessing how institutions could comply with potential leverage ratio requirements. The simulation assumed a baseline scenario of 50% capital build-up and 50% exposure reduction. Based on the quantitative analysis, the EBA concluded that a 3% leverage ratio is generally consistent with the objective of a backstop measure which supplements riskbased capital requirements. For around a third of the analysed institutions, a Tier 1 leverage ratio of 3% would constitute a higher capital requirement than a risk-based Tier 1 capital requirement of 8.5%. Amongst the sample, the weighted average leverage ratio was 4.4% while the median was 5.5%. As shown in Figure 1, a 3% leverage ratio requirement would result in a Tier 1 shortfall of EUR 6.4bn, with public development and mortgage representing the bulk. This is not surprising given the generally low-risk nature of the activities of these institutions. Based on the size of institutions, the shortfall stemmed from non-g-siis (Figure 2). Source: EBA QIS (June 2015) Of note, the quantitative benchmarking results indicated that there is potentially elevated exposure to the risk of excessive leverage in the case of the largest and most complex institutions, in particular for those who operate the business model of a cross-border universal bank and at the same are G-SIIs. This provides support for current Basel proposals considering additional requirements for systemically important such as a higher minimum or a buffer requirement or having limits on how much Additonal Tier 1 (AT1) capital may be used to satisfy the requirement. More rigorous requirements already exist in the UK, Switzerland and the US, and we would not be surprised if systemically important in Europe were subject to additional requirements (further details below). In the EBA analysis, G-SIIs and cross-border universal displayed weighted average leverage ratios of 4.1% and 4.2%, respectively. 25 April /6

3 Figure 2: Compliance by size of institution Source: EBA QIS (June 2015) The EBA also found that the potential impact of introducing a 3% leverage ratio requirement on the provision of financing by credit institutions was relatively moderate when put into the context of the overall size of the banking sector. The empirical results also revealed a very moderate increase in risk-taking at credit institutions which had a leverage ratio below 3% in 2010 (when Basel first introduced the measure). In addition, the leverage ratio was more sensitive to the economic cycle than risk-based capital requirements, and therefore potentially countercyclical. Based on further input from market participations, particularly qualitative considerations, the EBA will finalise its draft report over the next few months. The final report will be submitted to the European Commission by end July 2016 and be used as a basis for drafting potential leverage ratio legislation. 25 April /6

4 Positioning of G-SIBs in Europe As shown in Figure 3, for the G-SIBs rated by Scope, leverage ratios as of year-end 2015 were comfortably above 3% and ranged from 3.5% to 6%. For many, there has been a marked improvement in the leverage position over the last year, often driven by active deleveraging and restructuring in particular, for those involved in investment banking activities. Figure 3: Selected G-SIBs: year-end 2015 BIS leverage ratios 7% 6% 5% 4% 3% 2% 1% Transitional Fully-loaded 0% Notes: Some report only transitional or fully-loaded figures. BBVA will no longer be considered a G-SIB from Source: Company data, Scope Ratings International developments In December 2010, the Basel Committee introduced the leverage ratio with the following objectives: (i) to restrict excess leverage in the banking sector as this can damage the broader financial system and the economy and (ii) to reinforce risk-based requirements with a simple, non-risk based backstop measure. In January 2016, members of the Committee s oversight body agreed on a Tier 1 definition of capital and a minimum level of 3% for the leverage ratio. As well, additional requirements for G-SIBs were discussed. In 2016, calibration of the Basel III leverage ratio will be finalized to allow sufficient time for implementation as a Pillar 1 minimum capital requirement by 1 January In April 2016, the Committee published a consultation document with proposed revisions to the Basel III leverage ratio framework informed by the monitoring process that has been in place since 2013 and market feedback. Among the areas subject to revision are the measurement of derivative exposures, the treatment of provisions, credit-conversion factors for off-balance sheet items and additional requirements for G-SIBs. Composition of leverage ratio The Basel III leverage ratio is defined as the capital measure divided by the exposure measure, with this ratio being expressed as a percentage: Leverage ratio = Capital measure / Exposure measure The capital measure is Tier 1 capital as defined under Basel III and consists of CET1 and AT1 capital subject to adjustments, deductions and transitional arrangements. 25 April /6

5 The exposure measure comprises on-balance sheet exposures, derivative exposures, securities financing transaction (SFT) exposures and other off-balance sheet items (e.g. liquidity facilities, standby letters of credit and trade letters of credit). While exposures are not subject to risk-weights, different conversion factors apply to off-balance positions reflecting differences in the magnitude of their utilisation. Netting between assets and liabilities is generally not permitted although specific rules apply to SFTs (i.e. repurchase transactions, securities/commodities lending or borrowing transactions and margin lending transactions). Leverage ratio framework in UK UK G-SIBs and other major UK and building societies are subject to a minimum 3% leverage ratio requirement as well as a countercyclical leverage ratio buffer (set at 35% of the risk-weighted countercyclical buffer rate). As well, there is a supplementary leverage ratio buffer which is set at 35% of the corresponding risk-weighted systemic risk buffer rate this is being phased-in from 2016 to 2019 for G-SIBs and will be introduced in 2019 for other major domestic UK and building societies. For such as Barclays and HSBC, this translates into 2019 leverage ratio requirements close to 4%. Up to 25% of the minimum leverage ratio requirement of 3% can be met with high-trigger contingent capital (i.e. AT1 instruments with a trigger of at least 7%). The remainder as well as all leverage ratio buffers must be met with CET1 capital. Leverage ratio framework in Switzerland New capital rules for Swiss systemically relevant are expected to come into force as of 1 July 2016 with a four-year phase-in period. The proposed going concern capital requirements include a leverage ratio of 4.5% and a progressive buffer reflecting a bank s systemic importance. If the buffer is utilised, must take steps to restore it. For UBS and Credit Suisse, the progressive buffer is expected to be 0.5%, bringing the total going concern leverage ratio requirement to 5%. Of this, at least 3.5% must be met with CET1 capital and up to 1.5% may be met by high-trigger AT1 capital instruments. In addition, there would be a 5% gone-concern leverage ratio requirement. This requirement may be reduced by up to 2% if a bank takes measures to improve its resolvability. Leverage ratio framework in US From 1 January 2018, banking organisations subject to advanced approach risk-based capital rules must meet a minimum 3% leverage ratio. In addition, US bank holding companies that are G-SIBs (covered BHCs) are subject to a minimum 2% leverage buffer. If a covered BHC maintains a leverage buffer greater than 2%, it is not subject to limitations on distributions and discretionary bonus payments. Meanwhile, the insured depository institution subsidiaries of covered BHCs must maintain a leverage ratio of at least 6% to be considered well-capitalised. 25 April /6

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