Europe’s banks lose their cover on leverage ratio

April 11, 2014

By Dominic Elliott

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Europe’s banks have lost their cover on the leverage ratio. European lenders used to contend that American rivals had an easier ride on newly vogue-ish equity-to-asset yardsticks. New rules published on April 8 mean they can carp no longer.

Federal Reserve banking tsar Daniel Tarullo had flagged in advance that the absolute equity-to-assets level for U.S. banks to meet would be 6 percent, with a lesser 5 percent for their holding companies. What wasn’t so obvious was that the Federal Deposit Insurance Corporation would propose aligning its rules so closely with international standards laid out by Basel in January.

True, more lenient treatment still exists in America than elsewhere for the vital, but balance sheet-intensive business of repo – the financial sector’s equivalent of pawnbroking. But U.S. lenders, unlike European counterparts, are not able to issue contingent capital instruments that would count towards their leverage calculation.

More importantly, the FDIC has binned the use of U.S. Generally Applied Accounting Principles (GAAP), which had previously allowed American lenders to “net off,” or cancel out, big chunks of their balance sheet. Although some small differences remain, American rules are broadly in line with Basel’s. And Basel’s are designed to sidestep accounting conventions. From now on, balance sheets on both sides of the Atlantic will be more alike.

With similar methodologies, the glaring difference is that U.S. banks have a higher pass mark, which is why they will need an additional $68 billion – $46 billion more than on a GAAP-only basis. Although both Deutsche Bank and Credit Suisse have roughly a third of group assets in the States, the 2018 requirement for U.S. banks is double the 3 percent minimum required by Basel that applies to most European peers.

That almost certainly won’t last, however. It would be quite a surprise if European banks don’t soon have to sport leverage ratios of at least 4 percent, above where Deutsche Bank and Barclays now are. With more leveraged balance sheets to begin with, European banks like them would need a lot more capital. Despite apparently levelling the playing field, the U.S. rules may have pushed European banks towards fresh capital raises.

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