BOE Proposes Extra Leverage Restriction on U.K.’s Big Banks

Bank of England officials signaled they’re ready to toughen their stance on banks, saying lenders may have to further boost their leverage ratios.

“There may be a case to introduce a supplementary leverage ratio component to a subset of firms,” such as systemically important institutions “whose failure would be most destabilizing for the financial system,” the central bank said in a paper released today in London. It didn’t give details on the size of the extra leverage buffer.

Global regulators have been seeking ways to make banks safer after the collapse of Lehman Brothers Holdings Inc. in 2008 sparked a financial crisis and government-led bailouts around the world. The so-called leverage ratio has since been part of the Basel Committee on Banking Supervision’s armory, requiring banks to hold at least 3 percent in equity capital as a percentage of all their assets to cut firms’ debt reliance.

In the U.S., the largest bank holding companies will need to round up as much as $68 billion more in loss-absorbing capital under supplemental leverage ratio rules adopted by regulators. Eight lenders, including JPMorgan Chase & Co. and Bank of America Corp., are required to hold capital equal to at least 5 percent of total assets, surpassing Basel rules.

An increase in the leverage ratio “is almost inevitable as the U.S. are already at 5 percent or above,” said Benedict James, a partner at Linklaters LLP in London.

‘Market Failures’

Institutions have until Aug. 14 to respond to the BOE proposal, which follows a review of the use of the leverage ratio by the Financial Policy Committee, a central bank panel empowered to oversee and guard against risks to stability. Officials said that the additional requirement could be varied in a similar way to how capital levels are set in banks.

“The rationale for this surcharge is to lean further against some of the market failures,” the BOE said. “First, to make these banks safer because their distress or failure is particularly associated with negative effects on the wider economy and second, to reduce moral hazard created by their systemic importance such as funding cost advantages.”

Tougher Approach

The 42 biggest European Union banks had an average leverage ratio of 2.9 percent, the European Banking Authority said in September. It estimated that lenders that haven’t reached the Basel minimum level will need to raise 106 billion euros ($144 billion) by 2018. The leverage ratio excludes the perceived riskiness of banks’ assets.

Some policy makers have already called for a tougher approach. The current Basel minimum is “not enough,” Donald Kohn, a member of the BOE’s Financial Policy Committee, told lawmakers last year. BOE Governor Mark Carney ordered the five largest U.K. lenders, including Barclays Plc, to plug a 13.4 billion-pound capital shortfall to withstand possible losses on loans, fines and other risks.

Leverage ratios have also sparked regulators’ skepticism at banks’ use of their own risk models to calculate capital requirements.

The supervisor needs to have a “credible capacity” to withdraw a risk model if it’s seen as “inadequate” or the bank “has not demonstrated the capacity to use it safely,” Andrew Bailey, chief executive officer of the central bank’s Prudential Regulation Authority unit, told bank executives in a speech at Bloomberg L.P.’s London headquarters yesterday.

The FPC welcomes comments from interested parties “on all aspects of this paper,” the BOE said. Replies will feed into a final report to be published in November.

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