In November 2013 the Chancellor of the Exchequer asked the Financial Policy Committee (FPC) to conduct a review into the role for the leverage ratio within the capital framework for UK banks, and to consider the case for the FPC having the power to implement a leverage ratio requirement ahead of the international timetable, or to set a higher baseline ratio in some circumstances for UK banks.

On 15 October 2014, the FPC met to conclude its review and make its recommendation on the powers needed and the appropriate framework for a leverage ratio requirement in the UK. The Bank of England has now published a paper concerning the FPC’s review and its recommendation on both the framework and its calibration.

FPC recommendation

The FPC recommends that HM Treasury exercise its statutory power to enable the FPC to direct the PRA to set leverage ratio requirements and buffers for PRA-regulated banks, building societies and investment firms, including:

  • a minimum leverage ratio requirement;
  • a supplementary leverage ratio buffer that will apply to global systemically important banks (G-SIBs) and other major domestic UK banks and building societies, including ring-fenced banks; and
  • a countercyclical leverage ratio buffer.

Implementation

The FPC believes that the leverage ratio framework would be implemented as follows:

  • the minimum leverage ratio requirement would be set at 3% which the FPC judges to be consistent with domestic and international loss experience during historical banking crises;
  • supplementary leverage ratio buffers, which would be applied to systemically important firms (G-SIBs and other major domestic UK banks and building societies, including ring-fenced banks) would be set at 35% of the corresponding risk-weighted systemic risk buffer rates for these firms;
  • the FPC expects as a guiding principle that it would set  a countercyclical leverage ratio buffer (CCLB) rate at 35% of the risk weighted countercyclical capital buffer rate;
  • the definition for the exposure measure – the demoninator of the leverage ratio – would be aligned with the definition agreed by the Basel Committee on Banking Supervision, as implemented in European law;
  • for the capital resources measure – the numerator of the leverage ratio – additional Tier 1 capital instruments of sufficient quality to convert to common equity Tier 1 (CET1) capital on a going concern basis would be permitted to comprise up to 25% of the minimum requirement. Buffer requirements would be met with CET1 capital only;
  • though the FPC proposes no automatic supervisory actions following breaches of these leverage ratio requirements, it expects that the PRA would take timely and appropriate action to ensure that firms had a credible capital plan to remedy breaches;
  • for future stress tests, the FPC would expect regulatory responses to be based both on risk-weighted and leverage ratio requirements; and
  • in considering the appropriate calibration of the leverage ratio framework, the FPC recognises that relevant discussions on other capital requirements are still taking place internationally.

Timing

In relation to
timing the FPC states:

  • the minimum level of the leverage ratio of 3% would be introduced as soon as practicable for the UK G-SIBs and other major UK banks and building societies at the level of the consolidated group. The supervisory expectation that currently applies to these firms to maintain a 3% minimum leverage ratio would be superseded;
  • a supplementary leverage ratio buffer relating to G-SIBs would be implemented in parallel with the corresponding risk-weighted systemic risk buffers, which will be implemented from 2016;
  • a supplementary leverage ratio buffer relating to other domestic UK banks and building societies would be implemented in parallel with the corresponding risk-weighted systemic risk buffers. At present this would only apply to ring-fenced banks and large building societies. For these firms the risk-weighted systemic risk buffer will be set by the FPC following a consultation in 2015, and will be implemented from 2019;
  • changes to CCLB rates would be implemented at the same time as changes to CCB rates; the FPC sets the CCB rate for UK exposures quarterly. The CCB rates apply for all banks, building societies and large investment firms incorporated in the UK. Countercyclical leverage ratio buffers would be applied to firms at the point they become subject to the minimum leverage ratio requirement; and
  • the FPC has decided not to request a power of direction to set leverage ratio requirements for FCA-only regulated firms.

The FPC states that if legislation is introduced into Parliament to implement the proposed leverage ratio framework, it will publish a draft Policy Statement in early 2015 to inform the Parliamentary debate.

View The Financial Policy Committee’s review of the leverage ratio, 31 October 2014