UBS Tells Davos Leverage Ratio Over-Reliance Threatens Stability

UBS AG, Switzerland’s biggest bank, said a shift in emphasis to leverage ratios from risk-based capital measures could endanger financial stability.

“We caution against over-reliance on leverage ratios as a regulatory tool,” UBS said in a report, which the Zurich-based bank prepared for release at the World Economic Forum in Davos, Switzerland, and made available to Bloomberg. Such a focus “could lead to further deleveraging by banks and pose risks for financial stability.”

Some regulators in the U.S., the U.K. and Switzerland have highlighted the importance of the leverage ratio, which compares a bank’s equity to its total balance sheet, as an alternative to measures that rely on lenders to assign risk weightings to their assets.

Focusing mainly on a leverage ratio would set the wrong incentives for banks by encouraging them to hold riskier assets to boost returns, the report said. It could also lead to further asset reductions and capital raisings, threatening lending and an economic recovery, UBS said.

Even so, using a leverage ratio as a supplement to risk-based measurements could be useful, UBS said.

“Getting credit flowing again has been the key to recovery,” UBS said in the paper, which represents the views of 13 “opinion leaders” from the investment bank, wealth and asset management divisions. “We now have a fresh credit cycle at work in the U.S. and, to a degree, in the U.K. The euro zone is lagging behind, but given the framework set out by the European Central Bank, we should see good progress in 2014.”

‘Skewed’ Demand

The U.S. economy has benefitted from the fast recapitalization of the banks in 2008 and 2009, and also from its reliance on domestic demand, while other countries may need longer to recover, UBS said in the report, whose authors include Chief Investment Officer Alexander Friedman.

“The world economy remains just as unbalanced today as it has been over the past quarter century -- domestic demand is unhealthily skewed toward the U.S.,” it said. “Given that the U.S. economy does not have the same vitality that it did before the crisis, the export-led recoveries elsewhere will remain correspondingly weaker for longer.”

The U.S. also stands to benefit more from technological advances, according to UBS, which estimates that global economic growth could be 0.5 to 0.7 percentage points per year higher as a result of new technologies, while global inflation levels could be 1 percentage point lower.

U.S. Innovation

The U.S. “is at the forefront of many of these technological innovations,” UBS said. “The U.S. financial sector, above all in venture and private capital activities, arguably underpins more entrepreneurial activity than anywhere else.”

To keep up with technological changes and the availability of services on the Internet, banks need to adapt and offer low-cost services to clients, such as flat-fee products in wealth management, lower fees for trading in investment banking and a range of exchange-traded funds in asset management, or justify higher costs, the bank said. UBS started taking steps in this direction, it added.

“The challenge posed by a combination of advancing technology and new regulation is potentially greater than ever,” UBS said. “Banks can no longer seek to make money merely from acting as a middle man and charging for transactions.”

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