Matt Levine writes:\u00a0 Ever since about mid 2008, when everyone had a massive panic about bank capital, there has been a community of people who wanted to ignore the Basel Committee on Banking Supervision, and their \u201cTier One Ratio\u201d (based on equity divided by \u201crisk weighted assets\u201d or RWA). Instead, people like Anat Admati or Andy Haldane have suggested that we should just take the equity in the balance sheet, and divide it by the assets to get a \u201cleverage ratio\u201d without any of this complicated risk weighting stuff.<\/p>\n
Are they right? In my opinion, yes to the extent that they want to look at the leverage ratio, but very much no to the extent that they want to get rid of risk weighting. It\u2019s true that risk weighted assets and the Basel framework have gone badly wrong in the past and even contributed to some failures. But to take that as a reason for throwing the whole system away is not helpful.<\/p>\n
MYTH\u200a\u2014\u200aLeverage is a \u201csimple\u201d and objective calculation<\/p>\n
FACT\u200a\u2014\u200aOnly if you think that calculating a bank balance sheet is simple and objective<\/p>\n
MYTH\u200a\u2014\u200aLeverage is a more conservative standard than RWA<\/p>\n
FACT\u200a\u2014\u200aUnless you make major adjustments to the \u201csimple\u201d leverage ratio, it misses whole categories of risk.<\/p>\n
MYTH\u200a\u2014\u200aLeverage ratios can\u2019t be \u201cgamed\u201d by the banks.<\/p>\n
FACT\u200a\u2014\u200aLeverage ratios are very often gamed<\/p>\n
MYTH\u200a\u2014\u200aRisk weighted asset calculations are always fudged and faked by the banks<\/p>\n
FACT\u200a\u2014\u200aNo evidence has been found of this despite a dozen studies<\/p>\n
There are two, related, legitimate reasons why the leverage ratio is a big step forward.<\/p>\n
First, it acts as a checksum. Most of the things that a bank might do to fool the risk-weighted asset ratio would have the effect of making the balance sheet bigger and the leverage ratio worse. Most of the things that a bank might do to fool the leverage ratio would have the effect of piling up tail risks and making the risk-weighted assets ratio worse. It\u2019s comparatively difficult to think of measures which can fool both ratios at the same time.<\/p>\n
Second, and related to this, it helps to avoid \u201ccorner solutions\u201d. What you don\u2019t ever want to do in banking is to create the impression that a particular line of business has a zero capital requirement.\u00a0 If you have more than one ratio, you have much less chance that any activity is going to get a very low capital charge.<\/p>\n
Leverages are useful but not simple.\u00a0 Leveraging<\/strong><\/a><\/p>\n No Simple Answers<\/p><\/div>\n <\/p>\n","protected":false},"excerpt":{"rendered":" Matt Levine writes:\u00a0 Ever since about mid 2008, when everyone had a massive panic about bank capital, there has been a community of people who wanted to ignore the Basel Committee on Banking Supervision, and their \u201cTier One Ratio\u201d (based … Continue reading ![\"No](\"http:\/\/www.w-t-w.org\/en\/wp-content\/uploads\/2014\/10\/Leveraging-No-SImple-Answers-300x300.jpg\")
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