The Regulatory Leverage Ratio

Alan Adkins

This article was first published as a chapter in Basel III and Beyond, by Risk Books.

7.1 Introduction

This section examines the notion of leverage in the context of bank regulation and introduces the rest of the chapter.

What is leverage? What is a leverage ratio?

The etymology of the word “leverage” refers to the action of a lever. In finance, the term has been adopted to refer to various techniques by which cashflows, gains or losses are multiplied to provide proportionately larger returns to the owners or investors of a company, instrument or fund.

With regard to banking¹¹ The term “banking” is used here to describe all types of institution that take deposits and make loans. the term “leverage” is generally used to relate the extent to which the assets (and to some extent the off-balance-sheet commitments) of a bank are funded by equity, as opposed to deposit or other debt liabilities. The maturity transformation function that the banking sector performs means that it is an inherently leveraged industry. Therefore, the question for bank management and regulators is not whether leverage is desirable, but, rather, what is the appropriate degree of leverage