New Banking Leverage Ratio Requirement Gains Broad Support

The simple reserving formula and a 7% well-capitalized ratio credit unions employ is a more effective method for measuring capital adequacy.

 
 

In an April 12 article, the Financial Times endorsed the new U.S. banking leverage capital rules. According to its editorial, “Banks Should Be Made More Solid,” the tougher capital requirements imposed by a simple leverage ratio go a long way to lessen risk. The Times' endorsement of this approach provides a valuable perspective as NCUA proposes to impose a risk-based formula on credit unions — an approach the banking system has found to be wanting. 

The Times editorial follows the unanimous adoption by the OCC, the Fed, and the FDIC of a simple leverage ratio of 6% for banks and 5% for bank-holding companies. Banks and shareholders have had time to brace for the rule, which was originally proposed in July 2013, and the fact it is not scheduled to take effect until the start of 2018 gives institutions four years to adapt and raise capital.

Restoring Traditions With No Sound Opposing Argument

According to the editorial, the new capital proposals would restore traditions and "put the U.S. ahead of the Basel III requirement of a 3% leverage ratio." The editorial continues, “Uncomfortable as it is for the banks involved ... there is no sound argument against the idea.”

The editorial's brief summary of banking capital regulation notes that leverage ratios fell out of fashion after 1988 when the first Basel agreement was made. This agreement allowed banks to hold less capital against less risky assets such as mortgage loans and government sovereign debt. However, banks found ways to arbitrage the rules and expand their balance sheets.

The Times editorial concludes that the revival of the basic leverage ratio is overdue. “Finance has become too complex for society’s good and this is a useful counterbalance.”

Leverage Ratio More Conservative And Credible

Banking industry regulators have stated that using a tangible equity capital and total assets is a more conservative and more credible method for assessing capital adequacy. For credit unions, which start with no capital, their 100-year history suggests their simple reserving formula and a 7% well-capitalized ratio is a more effective method for measuring capital adequacy. 

In contrast, using the banking industry’s quarter-century experience with the risk-based approach, NCUA’s proposal appears to provide no benefit to either credit unions or their members.   

 
 

April 25, 2014


Comments

 
 
 
  • I think the article doesn't tell the whole story. In my experience the basic leverage ratio never fell out of favor with bank regulators. It was used in conjunction with the new BASEL based risk based capital ratios. The leverage ratio, tier 1 risk based capital ratio and the total risk based capital ratio each had requirements to be adequately or well capitalized. Risk weightings have been established based on perceived credit risk. This still has merit. For example, a bank holding only US Treasury Securities has a different risk profile than a bank holding unsecured commercial/industrial loans. Most people would agree that these two institutions would require different levels of capital to ensure the safety and soundness of the institution. The NCUA proposed capital rules are poorly done and should be fixed, but there is a useful purpose for capital requirements using a risk based approach.
    Larry