Calibrating the leverage ratio

Abstract

The Basel III leverage ratio (LR) is designed to restrict the build-up of leverage in the banking sector and to backstop the existing risk-weighted capital requirements (RWRs) with a simple, non-risk-weighted measure. But how should a minimum LR requirement be set? This special feature presents a conceptual framework for the calibration of the LR, focusing on the LR's cyclical and structural dimensions as well as its consistency with the RWRs. It then applies the framework to historical bank data. Subject to various caveats, it finds that there is considerable room to raise the LR requirement above its original 3% "test" level, within a range of about 4-5%. Doing so should help to constrain banks' risk-taking earlier during financial booms, providing a consistent and more effective backstop to the RWRs.

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