The Basel committee's effort to harmonize leverage rules will raise the heat on Wall Street. The global regulator wants banks to present a leverage ratio metric that would include additional notional values for derivatives. That would limit significantly the ability of American lenders to offset opposing derivatives trades.
Basel's proposals aim at creating the sort of level playing field that banks usually beg for. At the end of last year, none of the Wall Street's five largest banks - Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley - reported leverage of more than 20 times equity, as a result of the leniency of generally accepted accounting principles toward derivatives exposures. Investment banks in Europe, which report gross derivatives under stricter international financial reporting standards, had far higher leverage. The eight largest all exceeded 20 times leverage at the end of last year. Three banks had double that level.
If the five American banks had calculated leverage on the basis of gross derivatives, assets would have been at least 25 times equity, closer to their European peers, according to research by Barclays. What's more, Basel's move to enlarge American banks' assets would also be welcome by markets. A third of investors polled by Barclays in January felt gross asset numbers make banks' balance sheets more comprehensible.
Basel's allowance for leverage of up to 33 times is patently too high: just a 3 percent fall in assets would wipe out the equity of a bank with that level of gearing. But the committee deserves praise for widening the definition of assets, to prevent banks from gaming calculations. The rules aim to capture off-balance sheet items and repurchase agreements, or “repos,†which are like derivatives but are often accounted for as cashlike assets.
The methodology is overly complex in places and the prescription overly rigid. That may leave a generally sensible set of proposals vulnerable to lobbying in Wa shington.
Banks worldwide may also push regulators to define equity more generously. The Basel committee has said little so far about the numerator of the leverage equation, stating only that it looks at both more narrow Tier 1 common equity and total regulatory capital in parallel. Despite the progress, banks may yet push back on the latest attempt to keep them under control.
Dominic Elliott is a columnist at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.
