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FPC leverage ratio proposals ‘less draconian’ than feared

The mortgage industry was handed a boost last week as the Financial Policy Committee outlined its proposals for a new leverage ratio framework.

Under the proposed regime, lenders will have to comply with a leverage ratio of 4.95 per cent from 2019 – up from the current 3 per cent – which includes a supplementary buffer of up to 0.9 per cent. Without the buffer, the new capital requirement would be up to 4.05 per cent.

Larger banks, termed as systemically important to the global economy, would be forced to hold a buffer of up to 0.875 per cent above the current 3 per cent leverage ratio from 2016. 

The size of the buffer would be dependent on the size of the bank.

The proposed leverage ratio is lower than markets had expected. Analysts initially feared a minimum 5 per cent capital requirement for banks and building societies.

The Building Societies Association praised the FPC for responding to industry concerns.

A BSA spokeswoman says: “The FPC announcement demonstrates they have heard and responded to some of the multiple concerns that have been expressed about the impact of a high leverage ratio introduced early, particularly on areas such as mortgage availability and price. 

“The framework that the FPC is recommending to the Treasury is less draconian than we had feared although certain elements of the capital rules remain unwelcome.

“It was not new that the systemic firms were expected to meet a 3 per cent ratio. In our submission we called for any leverage ratio for the remainder of the banking sector to be introduced in line with the Basel 3 timetable and this is what has been announced.” 

A spokesman for the Council of Mortgage Lenders says: “We welcome the fact that the announcement of the leverage ratio was less draconian than some commentators feared. Lenders will also appreciate the flexibility in the definition of what qualifies as capital for the ratio and in the implementation timetable. 

“But the wider effects on the availability and cost of mortgage finance will only become clearer over time.”

GPS Economics director Gary Styles says the current leverage ratio of 3 per cent is too low but believes the FPC has acted sensibly in allowing for a phased introduction of a higher capital requirement.

Styles says: “Most economists agree the leverage ratio should be substantially higher than the current 3 per cent. The critical issue is how it is phased in and over what timescale. 

“If it is introduced too quickly, alongside the regulatory restrictions of the Mortgage Market Review as well as other lending caps from the Bank of England, then you run the risk of getting a reaction where lenders withdraw certain types of mortgage products and raise rates on those that remain.

“However, if you allow lenders time to build up to that required position, you avoid knee-jerk reactions. We are working towards the right level in terms of the leverage ratio and it seems to be planned over the right timeframe.” 

In June, Treasury select committee chairman Andrew Tyrie criticised the Bank of England’s proposals for a new leverage ratio framework, saying its plan was “more complicated than expected”.

However, following the publication last week, Tyrie said: “The Parliamentary Commission on Banking Standards concluded that the FPC – not politicians – should set the leverage ratio. Now they have made a start.

“It is crucial they do a good job. Too high a ratio and borrowing and economic growth are unnecessarily constrained; too low and the taxpayer is at risk from financial instability.

“The FPC may have found an ingenious, albeit somewhat complex, means of calibrating the leverage ratio to the risk-weighted capital framework. 

“The Treasury committee will be taking evidence on the extent to which they have succeeded, on the level itself and on other aspects of these important proposals.”

What is a leverage ratio?

It is a measure of the financial resilience of a bank. It is calculated by dividing the amount of capital the bank has available for absorbing losses by all the loans and financial assets it has on its books. The higher the number, the more resilient the bank should be.

How does this differ from other measures of bank capital?

Under existing Basel rules, capital strength has been measured according to the riskiness of a bank’s loans. However, regulators believe the financial crisis exposed flaws in this approach and have recommended a simpler leverage ratio alongside risk-weighted measures.

What will be the impact of a higher leverage ratio?

Building societies have warned a higher leverage ratio would deflate mortgage lending volumes and increase costs, while encouraging lenders to take more risk. Some lenders may need to raise more capital, which is difficult for mutuals.

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