Why the Bank Leverage Ratio Is Important | KPMG | ZA

Why the Bank Leverage Ratio Is Important

Why the Bank Leverage Ratio Is Important

South African banks are comfortably ahead of global banks in terms of the Basel committee’s new leverage requirements governing banks’ debt to equity ratios. The rules mean banks have to increase their equity levels further.



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The new hurdle has been widely criticised and comes at a time when overall capital ratios have improved. But lending has been rising only slowly and remains subdued in many developed countries. Leverage ratios have therefore been relatively low.

South African Regulation 38 (17) stipulates that a bank or controlling company, as the case may be shall manage their business at a leverage ratio at time less than 4% that is the inverse of the bank’s leverage ratio, shall at no time exceed 25, or such leverage ratio and multiple as may be determined by the Registrar in consultation with the Governor of the Reserve Bank, which leverage ratio shall in no case be less than 3 per cent.

At 8, 5%, Nedbank has the highest leverage ratio of local banks, followed by Absa (8%), Standard Bank (7, 1%) and FirstRand Bank (7%). (Source: The Financial Mail dated July 2013)

THE relaxation by the Basel Committee on Banking Supervision of some of its controversial leverage rules may encourage banks to increase lending, and in turn stimulate economic activity.

Many Banks are finding it difficult to stay abreast with the reporting requirements imposed on them. This is particularly due to:

  • Capital adequacy requirements and minimum leverage ratios are often spoken about as if they are one and the same. While they are similar in many respects, they are ultimately different concepts, and achieve different things;
  • Risk- based capital adequacy and minimum leverage ratios have been the cornerstone of the Basel framework since it was introduced 25 years ago. Leverage ratios, on the other hand, measure to the extent to which a bank has financed its assets with equity. It does not matter what those assets are, or what their risk characteristics. Leverage ratios effectively place a cap on borrowings as a multiple of a bank’s equity.
  • A common complaint for many years has been the inability to compare leverage ratios across jurisdictions because of material differences in accounting standards;
  • In terms of traditional on-balance sheet banking assets like loans and securities, nothing much has changed: an asset on the balance sheet is an exposure for leverage. If you count them one by one, there is no risk weighting.
  • Much of the focus has been directed at the treatment of exposures related to Repos (more technically termed securities financing transactions derivatives, and off balance sheet items like loan commitments.

The key things the Committee decided were:

  • Allowed a netting of Securities Financing Transactions (SFTs) but only where strict criteria were met (for example, same counterparty, same maturity date). In these cases, the net position provides a better measure of the degree of leverage in a set of transactions between counterparties and importantly, because SFT accounting is both arcane and inconsistent across various accounting standards. That is why the Committee has developed their own netting criteria to ensure internationally comparability
  • Allowed variation margin to be netted against derivative exposures – but only where the margin is paid in cashKept a firm limitation on the extent to which credit derivatives can be netted. In particular, banks can net long and short credit derivatives, but only on the same underlying and when the hedge has a maturity at least at long as the underlying. In other words, there can be no maturity mismatch
  • Determined that the most appropriate measure of exposure for off-balance sheet items would be their credit equivalent value. 

It is important to notice the following three important points:

  • The issue of calibration is still open,
  • Secondly, netting was permitted in the 2010 agreement – it is not new when it comes to  the leverage ratio- and potentially was permitted to a greater extent than has now been agreed,
  • A template is available in the market for public disclosure.

The template includes both gross and net information for SFT, and gross nominal and credit equivalents for off-balance sheet assets. 

For this reason, sound prudential controls are needed to ensure that private incentives do not result in excessive leverage Globally United States banking regulators have finalized and will soon announce a proposed leverage ratio for banks that was released for comment last July. 

The Federal Deposit Insurance Corporation has proposed the ratio at 5 percent for bank holding companies and 6 percent for insured bank depositories, most important, only high quality capital such as common equity and retained earnings would count for the numerator. 

At present the Basel Committees on Banking Supervision analysis continues on a minimum Tier I leverage of 3%. Some see this as too low, although until now it has hard to judges whether that is the case given that the Committee had not agreed on the denominator would be measured. 

Not only is there no transparency in how banks come up with their risk inputs, worse yet, this variability, or what many fear might be data manipulation, means that banks end up with very different levels of capital, which may or may not be sufficient to help them sustain unexpected losses.

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