Usability of capital buffers under a binding leverage ratio requirement

18. 1. 2021

Lukáš Pfeifer

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.

Issued: January 2021

Download: Thematic article on financial stability 6/2020 (pdf, 350 kB)