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The Basel III Tier 1 leverage ratio, first introduced in 2009, is a capital adequacy tool that measures a bank’s Tier 1 capital divided by its total exposures, including average consolidated assets, derivatives exposures and off-balance sheet items. Regulators and policy-makers believe that an underlying cause of the 2008 financial crisis was excessive leverage in the banking system, and so the intent behind the Basel III leverage ratio is to constrain the degree to which the bank can leverage its capital and improve the extent to which it can sustain negative shocks to its balance sheet.
The Basel standards require banks to maintain a Tier 1 leverage ratio of at least 3%. Global systemically important banks should maintain an extra leverage ratio buffer, which the Basel Committee agreed in December 2017 to set at 50% of a bank’s risk-weighted capital buffer.
National regulators have implemented their own versions of the Basel III leverage ratio in their respective jurisdictions. As the methodology does not take into account the risk weighting of specific assets, banks say it punishes certain businesses like clearing – where the real risks are offset by client margin held – or assets held at the central bank that are theoretically riskless.
However, many regulators consider a risk-insensitive leverage ratio an essential complement to the risk-based capital ratios that also form part of capital adequacy regimes. Regulators say one of the lessons of the crisis was that risk-weighted measures can misrepresent a bank’s actual safety and soundness, and so the leverage ratio is a necessary “backstop”.
See also Supplementary leverage ratio.
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