The EBA has recommended introducing a 3% Basel III leverage ratio (LR) to reduce the risk of excess leverage, or loans.

Basel III is a global, voluntary regulatory framework on bank capital adequacy, stress testing and market liquidity risk. It aims to strengthen bank resilience by increasing bank liquidity and decreasing bank leverage.

The LR is a “simple, transparent, non-risk-based measure to supplement existing risk-based capital adequacy requirements”, the EBA said.

EBA analysis suggests that the 3% level, alongside existing risk-based capital requirements, would provide a “backstop measure” against the risk of banks causing instability in the EU banking system, it said. 

The impact of a 3% LR on the provision of financing should be “relatively moderate” while risk taking “should not be strongly affected”, it said.

“The introduction of a 3% LR should lead to more stable credit institutions overall and the combined application of a risk-based ratio and an LR requirement will reduce the overall cyclicality of capital requirements,” the EBA said.

“A enormous number of empirical analyses own found that financial institutions globally increased leverage to excessive levels in the early 2000s. While higher levels of leverage at credit institutions compared to other operating institutions may generally be justified due to banks’ function of providing liquidity to claimholders and their special abilities with revere to managing risky assets through diversification, excessive levels of leverage build them exceedingly prone to shocks,” the EBA said.

The purpose of the leverage ratio (LR) regulation is therefore to limit the build-up of leverage to the degree that financial institutions do not complete up with excessive leverage while maintaining comfortable risk-based capital measures, it said.

The proposal is in line with discussions held by the Group of Central Bank Governors and Heads of Supervision in January 2016, the EBA said.

Central counterparties and central securities depositaries are already covered by other EU prudential regulations and should be exempted from this LR, the EBA said.

A higher level of LR may be warranted for global systematically important institutions, the EBA said.  

In the UK, the Prudential Regulation Authority already requires banks and building societies with assets in excess of £50bn to own a 3% minimum leverage ratio, while systemically important institutions own a higher ratio.