The Basel Committee introduced the leverage ratio because regulators thought that banks had too much discretion in the way risk-weighted assets were calculated. They have far less discretion in the way “total exposure” is calculated.

Things to Remember

1. Basel III is a global regulatory standard on bank capital adequacy, stress testing, and market liquidity risk. It was introduced by the Basel Committee on Banking Supervision following the financial crisis of 2007-2008 to strengthen the regulation, supervision, and risk management of banks.
2. The leverage ratio is a non-risk-based capital adequacy measure introduced under Basel III. It is calculated by dividing Tier 1 capital by the bank’s total exposures, which include on-balance sheet items, derivative exposures, and off-balance sheet items.
3. The leverage ratio serves as a backstop to the risk-based capital ratios. It helps ensure that banks have an adequate capital buffer against losses and restricts the level of leverage that banks can take on.
4. The main reason for the introduction of the leverage ratio was that banks had too much discretion in the way risk-weighted assets were calculated. This could lead to an underestimation of risk and lower capital requirements.
5. The calculation of the leverage ratio is more straightforward and leaves less room for manipulation compared to the calculation of risk-weighted assets.