What Is the Enhanced Supplementary Leverage Ratio (eSLR)?
The Enhanced Supplementary Leverage Ratio (eSLR) is a crucial regulatory metric within banking regulation that applies to the largest and most interconnected U.S. bank holding companies, known as global systemically important banks (GSIBs), and their subsidiary insured depository institutions. It serves as a non-risk-weighted backstop to traditional risk-weighted assets capital requirements, aiming to ensure these financial institutions maintain adequate capital requirements against their total exposures. The eSLR is designed to mitigate the buildup of excessive leverage in the banking sector, thereby enhancing overall financial stability. It measures a bank's Tier 1 capital against its total leverage exposure, which includes both on-balance sheet assets and certain off-balance sheet exposures.
History and Origin
The concept of a leverage ratio as a complementary measure to risk-based capital requirements gained prominence after the 2008 financial crisis. During the crisis, many banks maintained seemingly strong risk-based capital ratios but had built up excessive leverage, leading to destabilizing deleveraging processes that harmed the broader financial system. To address these shortcomings, the Basel Committee on Banking Supervision (BCBS) introduced a minimum leverage ratio as part of its Basel III framework in 2010, which became a Pillar 1 binding requirement in 2018.13,12,11
In the United States, regulators subsequently introduced the Enhanced Supplementary Leverage Ratio (eSLR) in 2014 to strengthen the overall regulatory capital framework for the largest and most interconnected U.S. bank holding companies. This built upon the Basel III standards by establishing higher minimum leverage ratio requirements for U.S. GSIBs and their major depository institution subsidiaries. The eSLR was set to require GSIBs to maintain a supplementary leverage ratio of at least 3% plus an additional buffer of 2%, effectively requiring an SLR of at least 5% at the holding company level and 6% at the insured depository institution subsidiary level for "well capitalized" status under prompt corrective action rules.10,9
Key Takeaways
- The Enhanced Supplementary Leverage Ratio (eSLR) is a non-risk-weighted capital requirement for the largest U.S. banks.
- It acts as a backstop to traditional risk-based capital rules, preventing excessive leverage build-up.
- The eSLR calculates Tier 1 capital as a percentage of total leverage exposure, including on- and off-balance sheet items.
- Recent proposals have aimed to recalibrate the eSLR buffer for GSIBs based on their systemic risk surcharge.
- The eSLR helps ensure banks maintain sufficient capital to absorb losses, contributing to financial stability.
Formula and Calculation
The Enhanced Supplementary Leverage Ratio (eSLR) is calculated by dividing a bank's Tier 1 capital by its total leverage exposure. It is expressed as a percentage.
The formula is:
Where:
- Tier 1 Capital: This includes common equity Tier 1 capital and additional Tier 1 capital, representing a bank's core capital elements available to absorb losses.
- Total Leverage Exposure: This comprises the sum of all on-balance sheet assets, plus specific "add-ons" for derivative exposures, securities financing transactions (SFTs), and credit conversion factors for various off-balance sheet exposures. The calculation for total leverage exposure aims to capture a comprehensive view of a bank's financial footprint.
Interpreting the eSLR
The Enhanced Supplementary Leverage Ratio provides a straightforward measure of a bank's leverage, independent of the perceived riskiness of its assets. A higher eSLR indicates a lower degree of leverage, meaning the bank has a larger cushion of Tier 1 capital relative to its total exposures. Regulators impose minimum eSLR requirements to ensure that banks can withstand financial shocks without relying heavily on debt.
Unlike risk-based capital ratios, which assign different weights to assets based on their risk, the eSLR treats all exposures equally. This simplicity is a key feature but also a point of debate. When interpreting the eSLR, it's important to understand its role as a "backstop." It's intended to catch leverage risks that might not be fully captured by more complex, risk-sensitive models. For bank holding companies, maintaining an eSLR above the required threshold is critical to avoid limitations on capital distribution and certain discretionary bonus payments.
Hypothetical Example
Consider "DiversiBank," a hypothetical global systemically important bank.
Scenario:
- DiversiBank's Tier 1 Capital: $100 billion
- DiversiBank's On-Balance Sheet Assets: $1.8 trillion
- DiversiBank's Off-Balance Sheet Exposures (after conversions): $0.2 trillion
Calculation of Total Leverage Exposure:
Total Leverage Exposure = On-Balance Sheet Assets + Off-Balance Sheet Exposures
Total Leverage Exposure = $1.8 trillion + $0.2 trillion = $2.0 trillion
Calculation of eSLR:
eSLR = ($100 billion / $2.0 trillion) × 100%
eSLR = 0.05 × 100% = 5%
In this example, DiversiBank has an eSLR of 5%. If the current minimum eSLR requirement for DiversiBank is 5% (e.g., a 3% baseline plus a 2% buffer), then DiversiBank meets the requirement. This indicates that for every dollar of Tier 1 capital, DiversiBank has $20 of total leverage exposure. A lower eSLR would signal higher leverage and potential regulatory scrutiny, impacting its ability to engage in activities like capital distribution or expansion.
Practical Applications
The Enhanced Supplementary Leverage Ratio is primarily a tool for prudential supervision and appears prominently in the regulatory frameworks governing large, complex financial institutions. Its practical applications include:
- Regulatory Compliance: GSIBs must continuously monitor and report their eSLR to ensure compliance with minimum capital standards. Failure to meet these thresholds can trigger prompt corrective action by regulators, leading to restrictions on activities.
- Backstop to Risk-Based Capital: The eSLR acts as a simplified, non-risk-weighted backstop to more complex risk-based capital rules. This prevents banks from gaming the risk-based models by holding seemingly low-risk, but highly leveraged, portfolios. Recent proposals by U.S. banking regulators, including the Federal Reserve, the Office of the Comptroller of the Currency (OCC), and the Federal Deposit Insurance Corporation (FDIC), aim to ensure the eSLR primarily functions as this intended backstop rather than a routinely binding constraint that might discourage low-risk activities like U.S. Treasury market intermediation.,
8*7 Systemic Risk Mitigation: By imposing higher leverage requirements on GSIBs, the eSLR aims to reduce systemic risk within the financial system. It limits the overall size of these institutions' balance sheets relative to their core equity, making them more resilient to adverse shocks. - Market Functioning: The calibration of the eSLR can influence banks' willingness to participate in certain markets. During periods of stress, a binding eSLR can disincentivize banks from holding low-risk assets like U.S. Treasury securities, which are crucial for market liquidity. Regulatory discussions, such as those highlighted by the Federal Reserve, explore recalibrating the eSLR to ensure it supports, rather than impedes, the smooth functioning of these vital markets.
6## Limitations and Criticisms
While the Enhanced Supplementary Leverage Ratio offers the benefit of simplicity and transparency, it also faces several limitations and criticisms:
- Indiscriminate Treatment of Assets: A primary critique is that the eSLR treats all assets equally regardless of their inherent risk. For instance, a highly liquid U.S. Treasury security counts the same as a much riskier corporate loan in the denominator of the leverage ratio. This can disincentivize banks from holding low-risk, low-return assets, potentially impacting the functioning of markets for safe assets, especially during periods of stress.
*5 Potential for Disincentivizing Low-Risk Activities: If the eSLR becomes the binding constraint for a bank (i.e., it requires more capital than the risk-based capital rules), banks may be less inclined to engage in low-margin, low-risk-weighted assets activities, such as providing liquidity in the U.S. Treasury market. This can have unintended consequences for market efficiency.
4 Cyclicality: Some argue that leverage ratios can be procyclical, meaning they amplify economic cycles. In a downturn, falling asset prices can lead to a decrease in Tier 1 capital and an increase in the leverage ratio, forcing banks to deleverage (sell assets or raise capital) when the economy is already weak, exacerbating the downturn. Conversely, in an upturn, rising asset values can lower the leverage ratio, potentially encouraging excessive risk-taking.,
32 Complexity in Exposure Measurement: While the concept of Tier 1 capital to total exposure is simple, the actual calculation of "Total Leverage Exposure" can be complex due to the inclusion of various off-balance sheet exposures and their specific conversion factors. - Focus on Quantity over Quality: Critics suggest that while the eSLR addresses the quantity of capital, it doesn't fully capture the quality of a bank's risk management practices or the underlying risks of its portfolio. The International Monetary Fund (IMF) has highlighted the need for broader views on leverage that consider factors beyond traditional balance sheet data, such as pledged collateral.
1## Enhanced Supplementary Leverage Ratio (eSLR) vs. Leverage Ratio
The Enhanced Supplementary Leverage Ratio (eSLR) is a specific, more stringent form of the general Leverage Ratio. The fundamental difference lies in their scope and the institutions to which they apply.
The Leverage Ratio is a broader regulatory measure, typically mandated for all banks as part of the Basel III framework. It is calculated as Tier 1 capital divided by total (non-risk-weighted) exposures. Its primary purpose is to serve as a simple, non-risk-based backstop to risk-weighted capital requirements for the entire banking system.
The Enhanced Supplementary Leverage Ratio (eSLR), however, is an additional, stricter requirement specifically imposed on Global Systemically Important Banks (GSIBs) in the United States and their key subsidiaries. It demands a higher minimum ratio than the standard Basel III leverage ratio and often includes a capital conservation buffer or GSIB surcharge component that makes it even more demanding. The eSLR aims to address the specific systemic risks posed by these very large and interconnected institutions, preventing them from building up excessive leverage that could destabilize the entire financial system. Therefore, while both are measures of leverage, the eSLR is an "enhanced" version targeting institutions whose failure could have widespread consequences.
FAQs
What is the primary purpose of the Enhanced Supplementary Leverage Ratio?
The primary purpose of the Enhanced Supplementary Leverage Ratio (eSLR) is to serve as a non-risk-weighted backstop to traditional risk-based capital requirements for the largest and most interconnected banks. It aims to prevent the build-up of excessive leverage that could pose a systemic risk to the financial system.
How does the eSLR differ from risk-weighted capital ratios?
The eSLR differs significantly from risk-weighted assets capital ratios because it treats all assets and exposures equally, regardless of their perceived risk. Risk-weighted ratios assign different capital requirements based on the riskiness of each asset, whereas the eSLR provides a simplified, non-risk-sensitive measure of a bank's overall leverage.
Why is the eSLR important for global systemically important banks (GSIBs)?
The eSLR is particularly important for GSIBs because these institutions are so large and interconnected that their failure could trigger widespread financial instability. By requiring higher leverage ratios for GSIBs, regulators aim to ensure these banks have a larger capital cushion, reducing the likelihood of taxpayer bailouts and promoting greater financial stability.