July 22 2016

German Banking Industry Committee and Austrian Economic Chambers: Position paper on the implementation of the leverage ratio in Europe

The leverage ratio is a non-risk based regulatory measure which will create a number of perverse incentives. It will also lead to inconsistencies between risk-weighted capital requirements and the leverage ratio, as we will demonstrate in detail below. The introduction of a non-risk based ratio will reverse a decades-old trend towards greater risk sensitivity in the capital requirements regime. This trend has been based on recognition of the fact that the regulatory objective of ensuring a bank’s solvency with a high degree of probability can only be achieved if its capital requirements are determined without overlooking any risk exposures. Major categories of risk such as market risk, operational risk and derivatives exposures can only be adequately captured by moving away from a balance-sheet approach and focusing instead on the associated risk. Regulatory capital requirements which do not consider exposure to loss are not a suitable means of ensuring solvency. On the contrary, they are counterproductive since they create incentives to engage in regulatory arbitrage, which actively undermines financial stability.

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