FIMPACT Newsletter No. 72 (dated 16th February 2015). Contact us at contact.investments@ifmr.co.

in

In the previous newsletter dated February 9, 2015, we provided an overview of change in regulations relating to debt
investments by Foreign Portfolio Investors in India. In this newsletter, we provide an overview on the new Leverage
Ratio requirement for banks under Basel III, introduced as a capital measure in addition to the risk-based capital
adequacy ratio.
Following the global financial crisis (GFC), the Basel Committee of Banking Supervision (Basel Committee) started
formulating a new banking supervision framework (Basel III) as the prevailing Basel II framework was found to be
inadequate in shielding the banking system from systemic financial crises. In addition to risk-based capitalisation
requirements, Basel III introduced a simple, transparent, non-risk based leverage ratio as a supplementary measure of
capitalisation. According to the Basel Committee, one of the underlying features of the financial crisis was the build-up
of excessive on- and off-balance sheet leverage in the banking system. In many cases, banks built up excessive
leverage while still showing strong risk based capital ratios, particularly in developed economies in North America and
Europe. During the peak of the crisis, most large banks were forced to de-leverage their balance sheet and,
irrespective of the quality of exposures, amplified downward pressure on asset prices, further exacerbating the vicious
cycle of losses, decline in bank capital, and contraction in credit availability.
The Indian banking system was reasonably protected from GFC on account of various reasons including limited
exposure to complex financial products due to a conservative regulatory regime, relatively lower share of exposures to
GFC-affected markets etc. However, the Reserve Bank of India has recognised the limitations of capital adequacy
ratio in times of systemic collapses and has introduced a leverage ratio requirement for Indian Banks as well in line
with Basel III recommendations.
The leverage ratio is intended to achieve the following objectives:

constrain the build-up of leverage in the banking sector, helping avoid destabilising deleveraging processes
which can damage the broader financial system and the economy; and
reinforce the risk based requirements with a simple, non-risk based backstop measure.

In India, the RBI also, being a signatory to the Basel Guidelines, notified the final guidelines relating to computation
and disclosure of Leverage Ratio.
Definition of leverage ratio and minimum requirements
Leverage ratio is computed using the formula given below:

It may be noted that banks are required to calculate leverage ratio on a consolidated basis. For the purpose of
consolidating subsidiaries / joint ventures engaged in financial services, the rules as applicable for computation of
Capital Adequacy Ratio shall be applied.
While the Basel III Committee has recommended a minimum of 3% leverage ratio (corresponding to a debt-equity
multiple of 33 times) during the transition period from 2013 to 2017, the Indian Banking System is currently operating
at a leverage ratio of more than 4.5% according to the RBI. The RBI has also mentioned that banks would be
monitored against an indicative leverage ratio requirement of 4.5% (corresponds to a debt-equity multiple of 22.22%)
until the final number is notified by the RBI.

FIMPACT Newsletter No. 72 (dated 16th February 2015). Contact us at contact.investments@ifmr.co.in

Capital Measure
Capital Measure has been defined to mean total Tier I capital as computed under Basel III regulations. This includes
eligible Additional Tier I Capital raised through instruments such as Perpetual Non-Cumulative Preference Shares
(PNCPS) and Perpetual Debt Instruments (PDI), but excludes Capital Conservation Buffer.

Only capital capable of absorbing losses would be considered for leverage ratio purposes.
Exposure Measure

Typically, the accounting value of all on-balance sheet exposures (including loan and investment exposures) is
included. It should be noted that the quality of exposures (viz., credit rating) is disregarded for this purpose. Further,
for the purpose of leverage ratio, banks are not allowed to net off collaterals / other available risk mitigations while
comparing on-balance sheet exposures.
Derivative exposures arising out of the underlying of the derivative contract and the counterparty credit risk must be
included for the purpose of leverage ratio. Typically derivative exposures are calculated as follows:

SFTs are transactions such as repo agreements, reverse repo agreements, security lending and borrowing, and
margin lending transactions, where the value of the transactions depends on market valuations and the transactions
are often subject to margin agreements. Bank exposure on SFTs is typically computed on a gross basis as the sum of
Gross SFT assets recognised for accounting purposes and a measure of the Counterparty Credit Risk.
Off balance sheet items include commitments (including liquidity facilities), whether or not unconditionally cancellable,
direct credit substitutes, acceptances, standby letters of credit, trade letters of credit, etc. OBS items are converted
under the standardised approach into credit exposure equivalents by applying credit conversion factors on the notional
amounts.
Leverage Ratio of Banks in India
RBIs Financial Stability Report for December 2014 pegs the systemic leverage ratio at 6.2% while for public sector
banks it was 5.2%.

FIMPACT Newsletter No. 72 (dated 16th February 2015). Contact us at contact.investments@ifmr.co.in

Figure 1: Leverage Ratio of Indian Banks

Figure 2: Capital Adequacy Ratio of Indian Banks

Source: Reserve Bank of India Financial Stability Report, December 2014

Although Indian Banks meet leverage ratio requirements at a systemic level, the stringent provisions of Basel III and
the non-equity Tier I capital instruments would necessitate significant fresh equity infusion into the banking system.
Various agencies have pegged the additional equity requirement for the domestic banking system at INR 1.5 to 2.5
trillion over the next 4-5 years.
Minimum leverage ratio requirements across Jurisdictions:
In line with Basel Committees position that the minimum Leverage Ratio requirement of 3% will be on a
recommendatory basis to be monitored until 2018, most countries have also taken similar positions. Nonetheless, the
minimum recommendatory requirement prescribed by most banking regulators are higher than the Basel Committee
recommendation.
Jurisdiction
NA
India
United States

Regulator
BIS recommendation
Reserve Bank of India
Federal Reserve

United Kingdom
Australia
Canada
China
Switzerland
South Africa
European Union
Singapore
Hong Kong
Brazil
Japan

Bank of England
Reserve Bank of Australia
Office of the Superintendent of Financial Institutions
Peoples Bank of China
FINMA
South African Reserve Bank
European Central Bank
Monetary Authority of Singapore
Hong Kong Monetary Authority
Central Bank of Brazil
Bank of Japan

Recommended Leverage Ratio

3%
4.5%
5%-6% (depending on size and
category of bank)
Minimum leverage ratio of 3%*
3%
5%
4%
4%
4%
Not published yet
Not published yet
Not published yet
Not published yet
Not published yet

* Additional supplementary leverage ratio of upto 3% may be prescribed for systemically important institutions and counter-cyclical
capital buffers

FIMPACT Newsletter No. 72 (dated 16th February 2015). Contact us at contact.investments@ifmr.co.in

Disclosure requirements
Banks are required to publicly disclose their Basel III leverage ratio on a consolidated basis from April 1, 2015, i.e.,
from the quarter ending June 30, 2015. Banks will also have to provide a reconciliation of material differences
between the balance sheet assets and the on-balance sheet exposures considered for computing the Leverage Ratio.

We hope you found this update useful. We welcome your feedback and suggestions at Investor.relations@ifmr.co.in.