Citi Analysts Jason Shoup, Sonam T Pokwal and Swati Verma review the current regulatory confusion regarding the leverage ratio in banks, and the implications for their business after implementation.

Leverage ratio

An earlier article titled ‘UBS Investment Research – The Vexed Question of Leverage and European Investment Banks’ appeared in Valuewalk on September 17.

Inconsistent capital regimes

The leverage ratio could be implemented with ‘material differences’ between the U.S., the U.K. and the rest of Europe – i.e. three distinct capital regimes, in the  words of the analysts. Differences exist in the schedules of implementation, the treatment of derivatives, the computation of the ‘numerator’ (CET1 or tier 1?), revisions to the definition of the ‘denominator by BCBS, and so on.

Impact of the BCBS on banking leverage ratios

The analysts estimate that full implementation of the BCBS revisions would lead to a reduction of 45bp in the U.S. and 35bp in Europe. But differences in business models amongst banks could lead to variations here. The treatment of derivatives by the banks could also lead to variations in the ultimate leverage ratio shortfall.

Impact on banks’ businesses

The result of the implementation of these regulations could be:

–       Bank balance sheets could come under pressure, and they may have to jettison low ROI businesses/assets such as certain derivatives, repo and reverse repo operations, cash or lending commitments.

–       These could have a domino effect, e.g. the curtailment of the repo and reverse repo operations could cause liquidity crunch in the money markets

–       Mortgage REITS that depend upon leverage provided by the banks to operate their business and pay dividends could be affected

–       Derivatives could come to be standardized, and routed through clearing houses

–       A reduction in repo could also exert pressure on general collateral rates

–       CDS curves could steepen

–       Banks may need to raise more capital