By capturing more off-balance sheet exposures in proposed leverage ratio requirements and simplifying the calculation of risk-weighted assets (RWAs), bank regulators could help bolster market confidence, Fitch Ratings said Thursday.
The rating agency says that the leverage ratio being proposed by the Basel Committee on Banking Supervision should be able to capture more risks by including off-balance sheet exposures. In contrast to traditional leverage metrics, the proposed ratio would force banks not only to hold capital against all assets, but it would also include exposures accounted for off-balance-sheet, Fitch says; which captures a wider swath of potential risks, and factors in differences in accounting standards.
“The Basel III leverage ratio should therefore be more comparable across banks globally than metrics based purely on unadjusted balance sheet totals. It should also be more useful for analysis once banks have fully disclosed consistent information, including the differences between financial statement assets and leverage ratio denominators,” it says.
That said, Fitch also notes that “leverage is a blunt measure, and ignores the extreme variation in risk among different asset classes.” Yet, it also observes that differences in RWA calculations “undermines investor trust and confidence in a risk-weighted approach.” And, it notes that recent studies by the Basel Committee have found substantial variance in trading and banking book risk weights, which reduces the comparability of capital ratios calculated using internal models.
Therefore, Fitch suggests, potential simplifications in the calculation of RWAs, which were raised in a recent Basel discussion paper, could help reduce underestimated risks from the use of internal models.
Indeed, it concludes that the use of the proposed leverage ratio, and possible measures to simplify RWA calculations, “should improve the consistency of both risk-based and non-risk-based approaches to bank capital, and in turn help restore market confidence.”