Basel II – leverage ratio not an option, says BBA chief

Ian Mullen

Last month (see "Basel II – US no closer to consensus"), Sheila Bair, chairman of the Federal Deposit Insurance Corporation, one of the US’s four main financial regulators, proposed that the US should maintain an existing leverage option, which sets a floor to minimum regulatory capital by using a percentage of assets, as a fall back to prevent the Basel approaches from reducing capital to too low a level. She also proposed that this option be adopted by all international banks so as to avoid competitive inequality.

This move was unsupported by two of the other US regulators, the US Federal Reserve and the Comptroller of the Currency, who felt it was late to start proposing such changes, and has met with little support from bankers or regulators anywhere else. In Europe, as the Capital Requirements Directive, the EU interpretation of Basel II, has now been finalised, such a change would now need an amendment to European law.

In an open letter to the Financial Times, Ian Mullen said "Risk management in banks, and banking regulatory practices, have evolved since the introduction of the leverage ratio in the US 15 years ago. Applying such a blunt instrument when bank capital is soon to be calculated in a much more risk-sensitive way under Basel II would be a backward step." He added that such a move would remove the incentive on banks to introduce sophisticated risk management practices and that the financial system would be worse off for this. He concluded "Banking regulators should have the courage of their convictions and resist overlaying a simplistic approach on the more sensitive Basel II framework that they have just created."