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Usability of capital buffers under a binding leverage ratio requirement

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  • Lukas Pfeifer

Abstract

A leverage ratio requirement designed to limit the risk of excessive leverage is to become binding in the EU in June 2021. In the expansionary phase of the cycle, associated primarily with constant or growing regulatory and voluntary capital buffers, those buffers aid compliance with the leverage ratio requirement, even in institutions with low aggregate risk weights. In the recessionary phase of the cycle, the use of the buffers may cause the leverage ratio to fall. In certain conditions, the usability of the capital buffers for covering losses may thus be constrained. This article illustrates the potential extent of this constraint in the Czech banking sector at present. The results indicate that the degree of non-usability of capital for loss absorption in the Czech banking sector at the end of the first half of 2020 would hypothetically have been 1.7 pp of the capital ratio. This signals that in certain extreme situations, the leverage ratio requirement may prevent the capital buffers from being fully effective.

Suggested Citation

  • Lukas Pfeifer, 2021. "Usability of capital buffers under a binding leverage ratio requirement," Occasional Publications - Chapters in Edited Volumes,, Czech National Bank, Research and Statistics Department.
    • Handle: RePEc:cnb:ocpubc:tafs2020/6
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    File URL: https://www.cnb.cz/export/sites/cnb/en/financial-stability/.galleries/thematic-articles-on-financial-stability/tafs_2020_06_en.pdf
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    References listed on IDEAS

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    1. Libor Holub & Tomas Konecny & Lukas Pfeifer & Vaclav Broz, 2020. "The CNB's approach to releasing the countercyclical capital buffer," Occasional Publications - Chapters in Edited Volumes,, Czech National Bank, Research and Statistics Department.
    2. Lukas Pfeifer & Libor Holub & Zdenek Pikhart & Martin Hodula, 2016. "The Role of the Leverage Ratio in Capital Regulation of the Banking Sector," Occasional Publications - Chapters in Edited Volumes, in: CNB Financial Stability Report 2015/2016, chapter 0, pages 137-148, Czech National Bank, Research and Statistics Department.
    3. Michael Brei & Leonardo Gambacorta, 2016. "Are bank capital ratios pro-cyclical? New evidence and perspectives," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 31(86), pages 357-403.
    4. Lukáš Pfeifer & Martin Hodula, 2021. "New kid on the block: leverage ratio and its implications for banking regulation," The European Journal of Finance, Taylor & Francis Journals, vol. 27(10), pages 1009-1028, July.
    5. Acosta-Smith, Jonathan & Grill, Michael & Lang, Jan Hannes, 2024. "The leverage ratio, risk-taking and bank stability," Journal of Financial Stability, Elsevier, vol. 74(C).
    6. Mikael Juselius & Mathias Drehmann, 2015. "Leverage dynamics and the real burden of debt," BIS Working Papers 501, Bank for International Settlements.
    7. Václav Brož & Lukáš Pfeifer, 2021. "Are risk weights of banks in the Czech Republic procyclical? Evidence from wavelet analysis," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 10(1), pages 113-139.
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