Definition
The leverage ratio compares Tier 1 capital with the institution's total exposure measure, with no risk weighting. It acts as a backstop: it limits the build-up of exposures that models consider low-risk, which weigh little in RWA but expand the balance sheet.
Calculation method
Leverage ratio = Tier 1 / total exposure measure.
- On-balance-sheet exposures, excluding derivatives and securities financing transactions, net of certain deductions.
- Derivatives: replacement cost and potential future exposure, under the standardised approach for counterparty credit risk.
- Securities financing transactions (repos, securities lending and borrowing), with limited netting.
- Off-balance-sheet items: commitments converted into on-balance-sheet equivalents with credit conversion factors, floored at 10%.
Regulatory requirement
The CRR (Articles 92 and 429 onwards) has imposed a minimum leverage ratio of 3% since June 2021. Global systemically important institutions (G-SIIs) must also hold a buffer equal to half their G-SII buffer. The supervisor may set a Pillar 2 requirement for the risk of excessive leverage. The ratio is reported in supervisory reporting and disclosed under Pillar 3.
Practical challenges
- Measuring derivatives and securities financing transactions, which requires precise netting and collateral data.
- Tracking exemptions, for example for certain central bank or intragroup exposures.
- Projecting the ratio in the capital plan, consistently with the capital ratios.
In RIALTO
This concept is covered by the Solvency Insight Core module. The use case 'Stress simulation' shows it in practice.