Analysts Daniele Brupbacher, John-Paul Crutchley, Nick Davey, Anton Kryachok and Mate Nemes examine the impact of upcoming statutory stipulations regarding leverage on select European banks in their report dated September 16, 2013.

European Central Bank leverage

Basel 3 leverage ratio stipulations

The analysts are unequivocal in their view that Basel 3 leverage ratio stipulations will impose a heavy toll on banks’ abilities to promote growth and maintain dividend payments.

But, in all fairness, they point to the increasingly strident arguments both for and against leverage ratios, as well as the plethora of definitions that surround a deceptively simple financial ratio.

Proponents for the ratios say that banks would likely manage the final leverage ratio requirements without sacrificing revenue, assuming the ratio is close to the current CRD IV rules. They cite the example of Credit Suisse Group AG (ADR) (NYSE:CS), which has demonstrated a successful reduction in exposure without giving up revenues majorly, and go on to say that banks can boost the ‘numerator,’ i.e. issue additional Tier 1 capital. Thomas Hoenig, Vice Chairman, FDIC: Higher capital requirements imposed by leverage ratio requirements enhance banks’ abilities to withstand financial shocks and continue lending. “It is simply a fact that the banks that have been most successful over the long run are those that held more and better capital than their competitors.”

Large banks behind the curve

Those against leverage ratios, and this is the consensus view according to UBS AG (NYSE:UBS) (VTX:UBSN), say that certain large banks, such as Deutsche Bank AG (NYSE:DB) (ETR:DBK) (FRA:DBK), are already behind the curve on this issue, and that extensive deleveraging would be necessary—so much so that ROE targets would be missed and earnings projections may have to be revised. Sabine Lautenschlager, deputy president, Bundesbank: “In Germany there are banks with high leverage but a large part of their business is financing the German government and German communities. You wouldn’t say these banks are high-risk.”

So, there you have it. The report goes on to examine the impact of the variously defined leverage ratios on European Investment Banks.

The table below shows UBS’ projections for Basel 3 defined leverage ratios for key European Investment Banks vis-à-vis the target:

Leverage

Latter route could chop revenues

With only two routes to lower the leverage ratios (increase CET1 to > 10 percent, or reduce exposures) UBS feels the latter route could chop revenues in the low- to mid-single-digit percentage point range.

In any case, UBS AG (NYSE:UBS) (VTX:UBSN) project that most banks will achieve fully loaded leverage ratio of 3 percent as early as 2013 and 4 percent by 2015. However, a 100bps gap could stretch between various methodologies, and the gap could be larger if the goalposts are moved by making the minimums higher, e.g. 6 percent in the U.S.

Current ratings by UBS AG (NYSE:UBS) (VTX:UBSN) are:

Buy:

Credit Suisse Group AG (ADR) (NYSE:CS), Deutsche Bank AG (NYSE:DB) (ETR:DBK) (FRA:DBK)

Neutral:

BNP Paribas SA (EPA:BNP) (OTCMKTS:BNPQY), Barclays PLC (ADR) (NYSE:BCS) (LON:BARC)

Sell:

Societe Generale SA (ADR) (OTCMKTS:SCGLY) (EPA:GLE)