Glossary term
Leverage Ratio
Subject: Risk Management, Prudential and Capital Risk
This ratio compares a bank's core capital with its total exposures, with no adjustment for risk. It works as a simple backstop to the risk-based capital rules.
Explanation
Risk-based capital rules depend on risk weights and internal models, and both can understate danger. This measure ignores them. It divides high-quality capital, mainly Tier 1, by a broad measure of exposure that covers balance-sheet assets and certain off-balance-sheet items such as derivatives and loan commitments. Every exposure counts at full size, so a bank packed with low-weighted assets cannot hide thin capital. Basel III set an international minimum of 3%, and many jurisdictions ask the largest banks for more. Supervisors treat it as a floor that sits beside the risk-weighted ratios, not a replacement for them. You meet it in bank disclosures and in debates about how thinly a lender is funded. Without it, a lender holding a huge book of low-weighted assets could look well capitalised on the risk-based ratio while owning very little loss-absorbing capital.
Example
A bank reports a healthy risk-weighted capital ratio because most of its holdings carry low risk weights. Its core capital is 30 against total exposures of 1,000, a ratio of 3%. The supervisor notes the bank sits right on the floor and asks how it would fund further growth without raising capital.
Not to be confused with
- Capital adequacy ratio
- The capital adequacy ratio weights assets by risk. This ratio counts every exposure at full size.