ABBL replied to the Basel consultation on “Strengthening the Resilience of the Banking Sector”
20 April 2010
In ABBL view, what is relevant is not the leverage as such, but rather the risks that are leveraged by a bank. Hence, a leveraged portfolio composed of non-risky assets may well be less risky than a non-leveraged portfolio composed of risky assets.
Any measure of leverage does not say anything about the level of risk incurred by a bank, whether market, credit or liquidity risks. In ABBL view, what is relevant is not the leverage as such, but rather the risks that are leveragedby a bank. Hence, a leveraged portfolio composed of non-risky assets may well be less risky than a non-leveraged portfolio composed of risky assets.
If it were implemented as a binding “Pillar 1” limit, the leverage ratio would equally hit banks that leverage risky and/or illiquid assets (investment banks for example) and those leveraging non-risky and liquid asset. The Luxembourg banks belong to the latter category, because they are mostly involved in retail, private banking, asset management, custodian and also Covered Bonds activities.
Having said that, ABBL understands the concerns of the regulatory community concerning the level of leverage in the financial sector. It is true that the leverage amplifies the effects of risk and increases the systemic vulnerability arising from the (risky) leveraged positions.
In that regard, the crisis has highlighted some loopholes in the banking regulatory framework coupled with incentives in favour of regulatory arbitrage, mainly:
- Some risky and illiquid products were not charged the right capital requirement by the Basel 2 framework because they were booked in the trading book instead of the banking book
- The liquidity risk framework failed to capture the big maturity mismatches relying on excessive wholesale funding
Leverage therefore amplified the impacts of such risky behaviours. Conversely, leverage remained neutral for banks active in conservative and well-diversified businesses.
The ABBL long standing position is that the current prudential framework must be improved by defining more severe rules for risky and speculative activities and by prohibiting any kind of regulatory arbitrage. The new Basel framework proposed for the trading book and for the liquidity rules, if properly calibrated, will reduce such risks. By addressing the roots of the problem, they will undoubtedly mitigate the potential effects of the leverage.
© ABBL - Luxembourg Bankers’ Association
