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Basel iii leverage ratio

What Is Basel III Leverage Ratio?

The Basel III Leverage Ratio is a non-risk-based measure designed to constrain the build-up of excessive leverage within the banking system and to act as a crucial backstop to risk-based capital requirements. This ratio falls under the broader category of Bank Capital Regulation, which aims to ensure the stability and resilience of financial institutions. The Basel III Leverage Ratio is calculated as a percentage, representing a bank's core capital in relation to its total unweighted exposures. It was introduced as part of the Basel III reforms to complement existing risk-weighted measures and provide a simpler, more transparent indicator of a bank's financial strength.67, 68, 69

History and Origin

The financial crisis of 2007–2009 exposed significant vulnerabilities in the global banking system. A key issue identified was that many banks had accumulated excessive on- and off-balance sheet items leverage, even while appearing to meet seemingly strong risk-based capital ratios. The subsequent period of deleveraging intensified losses and restricted the availability of credit, causing widespread damage to the financial system and the real economy.

65, 66In response to these deficiencies, the Basel Committee on Banking Supervision (BCBS), an international body that sets standards for banking regulation, developed the Basel III framework. The introduction of a simple, non-risk-based leverage ratio was a central component of these reforms. The BCBS first outlined a proposal for the leverage ratio in December 2009, with the final framework and disclosure requirements published in January 2014. The intent was to prevent future periods of destabilizing leverage build-up and reinforce the risk-based capital framework with a straightforward "backstop."

60, 61, 62, 63, 64For more on the history and evolution of these global banking standards, consult the History of the Basel Committee.

Key Takeaways

  • The Basel III Leverage Ratio is a non-risk-based measure of a bank's financial soundness, complementing risk-weighted capital requirements.
    *58, 59 It is calculated by dividing Tier 1 capital (the capital measure) by a broad measure of total exposures (the exposure measure), expressed as a percentage.
    *55, 56, 57 The primary goal is to limit excessive on- and off-balance sheet exposures and restrict the build-up of unsustainable leverage in the banking system.
    *53, 54 A minimum Basel III Leverage Ratio of 3% was initially set, with some jurisdictions, like the U.S., implementing higher requirements for larger institutions.
    *51, 52 It serves as a "backstop," acting as a safety net against potential shortcomings or manipulation in risk-weighted asset calculations.

48, 49, 50## Formula and Calculation

The Basel III Leverage Ratio is defined as the capital measure (numerator) divided by the exposure measure (denominator), expressed as a percentage.

46, 47$$
\text{Leverage Ratio} = \frac{\text{Tier 1 Capital}}{\text{Exposure Measure}} \times 100%

Where: * **Tier 1 Capital:** This is the capital measure, representing a bank's highest quality, loss-absorbing [regulatory capital](https://diversification.com/term/regulatory-capital). It includes common equity and certain other qualifying instruments, with deductions for items like goodwill. *[^42^](https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf), [^43^](https://www.ibm.com/docs/en/bfmdw/8.10.1?topic=accord-basel-iii-summary), [^44^](https://www.congress.gov/crs_external_products/IF/HTML/IF10205.web.html), [^45^](https://www.pfandbrief.de/wp-content/uploads/2025/01/20140112_bcbs_270_Leverage_Ratio_en.pdf) **Exposure Measure:** This is the denominator, a broad sum of a bank's exposures. It includes [on-balance sheet exposures](https://diversification.com/term/on-balance-sheet-exposures), derivative exposures, securities financing transaction (SFT) exposures, and [off-balance sheet items](https://diversification.com/term/off-balance-sheet-items). Unlike risk-weighted assets, this measure does not generally differentiate between the riskiness of assets; all exposures are treated equally for this calculation. [^39^](https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf), [^40^](https://www.pfandbrief.de/wp-content/uploads/2025/01/20140112_bcbs_270_Leverage_Ratio_en.pdf), [^41^](https://www.clarusft.com/basel-iii-leverage-ratio/)For off-balance sheet items, credit conversion factors (CCFs) are applied to convert them into on-balance sheet equivalents, subject to a minimum floor. [^38^](https://www.bis.org/publ/bcbs270.htm)## Interpreting the Basel III Leverage Ratio A higher Basel III Leverage Ratio indicates a stronger capital position relative to a bank's total exposures, implying a greater capacity to absorb potential losses. Conversely, a lower ratio suggests higher indebtedness. T[^37^](https://www.bundesbank.de/.enodia/challenge?redirect=%2Fen%2Ftasks%2Fbanking-supervision%2Findividual-aspects%2Fleverage-ratio-622882)he minimum requirement for the Basel III Leverage Ratio is generally 3%. However, systemically important financial institutions (SIFIs) in certain jurisdictions, such as the U.S., are subject to higher requirements, often around 5% or 6% for holding companies and their banking subsidiaries, respectively. [^35^](https://www.ibm.com/docs/en/bfmdw/8.10.1?topic=accord-basel-iii-summary), [^36^](https://www.financialresearch.gov/the-ofr-blog/2024/08/02/banks-supplementary-leverage-ratio/)This ratio provides a straightforward view of a bank's leverage, unburdened by the complexities and potential variability of risk-weighted assets calculations. Regulators use it to ensure that banks maintain a fundamental level of capital regardless of the perceived riskiness of their assets, acting as a safeguard against potential underestimation of risk. [^33^](https://www.risk.net/definition/leverage-ratio), [^34^](https://www.congress.gov/crs_external_products/IF/HTML/IF10205.web.html)## Hypothetical Example Consider a commercial bank, "Diversified Lending Corp." (DLC), reporting its financial data: * **Tier 1 Capital:** $10 billion * **On-balance sheet assets:** $250 billion (e.g., loans, cash, securities) * **Derivative exposures (net of eligible collateral):** $20 billion * **Securities financing transaction exposures:** $15 billion * **Off-balance sheet items (after applying CCFs):** $40 billion To calculate DLC's Basel III Leverage Ratio: 1. **Calculate the Total Exposure Measure:** $250 \text{ billion (on-balance sheet)} + 20 \text{ billion (derivatives)} + 15 \text{ billion (SFTs)} + 40 \text{ billion (off-balance sheet)} = 325 \text{ billion}$ 2. **Apply the Formula:** $$ \text{Leverage Ratio} = \frac{\text{Tier 1 Capital}}{\text{Exposure Measure}} \times 100\% \\ \text{Leverage Ratio} = \frac{\$10 \text{ billion}}{\$325 \text{ billion}} \times 100\% \\ \text{Leverage Ratio} \approx 3.08\% $$ In this hypothetical scenario, Diversified Lending Corp. has a Basel III Leverage Ratio of approximately 3.08%. This indicates that it meets the minimum 3% threshold, but depending on its classification (e.g., as a systemically important financial institution), it might be required to hold a higher ratio. ## Practical Applications The Basel III Leverage Ratio is a cornerstone of global [bank capital regulation](https://diversification.com/term/regulatory-capital), with several practical applications: * **Regulatory Compliance:** Banks, especially internationally active ones, must adhere to the minimum Basel III Leverage Ratio set by their national regulators. This ensures a baseline level of capital adequacy across diverse [banking system](https://diversification.com/term/banking-system)s. *[^32^](https://www.risk.net/definition/leverage-ratio) **Complement to Risk-Based Ratios:** It acts as a non-risk-sensitive complement to risk-weighted assets requirements. This dual approach helps prevent banks from excessive leverage, particularly in periods when risk-weighted models might underestimate actual risks. *[^31^](https://jollycontrarian.com/index.php?title=Leverage_ratio) **Supervisory Tool:** Regulators use the Basel III Leverage Ratio, alongside other metrics like stress tests and other [capital requirements](https://diversification.com/term/capital-requirements) (e.g., [liquidity coverage ratio](https://diversification.com/term/liquidity-coverage-ratio) and [net stable funding ratio](https://diversification.com/term/net-stable-funding-ratio)), to monitor the financial health and stability of individual banks and the broader financial system. *[^29^](https://www.ecb.europa.eu/pub/pdf/fsr/art/ecb.fsrart201511_01.en.pdf), [^30^](https://www.bankingdive.com/news/fed-capital-framework-bowman-powell-bessent-quarles-mayo/753681/) **Market Discipline and Transparency:** Public disclosure of the Basel III Leverage Ratio enhances transparency, allowing market participants to better assess a bank's financial strength and compare it across institutions. [^27^](https://www.bis.org/publ/bcbs270.htm), [^28^](https://www.congress.gov/crs_external_products/IF/HTML/IF10205.web.html)For more details on the U.S. implementation and monitoring of this ratio, refer to the Office of Financial Research's brief on [Banks' Supplementary Leverage Ratio](https://www.financialresearch.gov/briefs/files/OFR-Brief-24-03-Banks-Supplementary-Leverage-Ratio.pdf). ## Limitations and Criticisms Despite its intended benefits, the Basel III Leverage Ratio has faced several limitations and criticisms: * **Risk-Insensitivity:** A major critique is its uniform treatment of all assets, regardless of their inherent [credit risk](https://diversification.com/term/credit-risk). This means a bank must hold the same amount of capital against a low-risk government bond as it does against a higher-risk corporate loan. Critics argue this can disincentivize holding low-risk, liquid assets and potentially lead banks to prefer riskier investments to maximize returns on their limited capital. *[^23^](https://www.risk.net/definition/leverage-ratio), [^24^](https://fastercapital.com/topics/challenges-and-limitations-of-tier-1-leverage-ratio.html/1), [^25^](https://www.clarusft.com/basel-iii-leverage-ratio/), [^26^](https://www.americanprogress.org/article/3-flawed-banking-industry-arguments-against-a-key-postcrisis-capital-requirement/) **Potential for Distortions:** The ratio might create unintended distortions in banks' business models. For example, some argue it could penalize business lines with high volumes of low-risk transactions, such as clearing services, where large exposures are offset by client margins. *[^22^](https://www.risk.net/definition/leverage-ratio) **Calibration Concerns:** There has been debate over the appropriate calibration of the minimum ratio. Some analyses suggest that even higher ratios might be necessary to achieve the desired level of banking stability and that a 3% ratio might not be sufficiently conservative to prevent collapses during severe stress events. *[^20^](https://www.risk.net/regulation/basel-committee/2449151/limits-leverage-ratio), [^21^](https://ideas.repec.org/p/pra/mprapa/61330.html) **Cross-Jurisdictional Differences:** Differences in national accounting standards can impact the calculation of total assets, potentially leading to inconsistencies in how the Basel III Leverage Ratio is applied across countries, even with a fixed ratio. This could create an uneven playing field. [^18^](https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf), [^19^](https://www.brookings.edu/articles/basel-iii-the-banks-and-the-economy/)A discussion of these challenges and the broader economic implications can be found in the Brookings Institution article, [Basel III, the Banks, and the Economy](https://www.brookings.edu/articles/basel-iii-the-banks-and-the-economy/). ## Basel III Leverage Ratio vs. Risk-Weighted Assets The Basel III Leverage Ratio and risk-weighted assets (RWAs) are both fundamental components of [bank capital regulation](https://diversification.com/term/regulatory-capital) under Basel III, yet they serve distinct purposes and operate differently. | Feature | Basel III Leverage Ratio | Risk-Weighted Assets (RWAs) | | :------------------ | :------------------------------------------------------------ | :------------------------------------------------------------ | | **Purpose** | Simple, non-risk-based backstop to excessive leverage. | Risk-sensitive measure reflecting potential losses from assets. | | **Calculation** | Tier 1 capital divided by total unweighted exposures (on- and off-balance sheet). | Assets are assigned risk weights based on their perceived risk, then summed. | | **Risk Sensitivity**| Not sensitive to asset riskiness; treats all exposures equally. | Highly sensitive to asset riskiness; higher risk assets require more capital. | | **Transparency** | Generally considered more transparent and simpler to understand. | More complex, relying on internal models or standardized approaches, which can be opaque. |[^15^](https://www.congress.gov/crs_external_products/IF/HTML/IF10205.web.html), [^16^](https://jollycontrarian.com/index.php?title=Leverage_ratio), [^17^](https://www.elibrary.imf.org/display/book/9781484310717/ch010.xml) | **Complementarity** | Designed to complement RWAs by capturing leverage not addressed by risk-weighted measures. | The primary measure for assessing a bank's capital adequacy against its diverse portfolio of risks. | While RWAs aim to provide a granular assessment of a bank's [credit risk](https://diversification.com/term/credit-risk), market risk, and operational risk, they were criticized after the 2008 [financial crisis](https://diversification.com/term/financial-crisis) for their complexity and potential for understating actual risks. The Basel III Leverage Ratio was introduced as a robust, albeit blunt, tool to counteract these issues, ensuring that banks maintain a basic level of capital irrespective of complex risk models. T[^13^](https://www.congress.gov/crs_external_products/IF/HTML/IF10205.web.html), [^14^](https://jollycontrarian.com/index.php?title=Leverage_ratio)he two measures are intended to work in tandem, providing a more comprehensive view of a bank's financial stability. [^12^](https://www.americanprogress.org/article/3-flawed-banking-industry-arguments-against-a-key-postcrisis-capital-requirement/)## FAQs ### What is the primary purpose of the Basel III Leverage Ratio? The primary purpose of the Basel III Leverage Ratio is to serve as a simple, non-risk-based "backstop" to the more complex risk-weighted [capital requirements](https://diversification.com/term/capital-requirements). It aims to prevent the build-up of excessive leverage, both on and off a bank's balance sheet, which was identified as a key contributor to the 2008 [financial crisis](https://diversification.com/term/financial-crisis). [^9^](https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf), [^10^](https://www.ecb.europa.eu/pub/pdf/fsr/art/ecb.fsrart201511_01.en.pdf), [^11^](https://www.bis.org/basel_framework/chapter/LEV/20.htm)### How is the Basel III Leverage Ratio different from risk-weighted capital ratios? Unlike risk-weighted assets (RWAs) which assign different capital requirements based on the perceived riskiness of assets, the Basel III Leverage Ratio treats all exposures equally. It is a simpler measure that does not account for the specific risk of each asset, acting as a broad safety net. [^6^](https://www.risk.net/definition/leverage-ratio), [^7^](https://www.clarusft.com/basel-iii-leverage-ratio/), [^8^](https://jollycontrarian.com/index.php?title=Leverage_ratio)### What is considered a "good" Basel III Leverage Ratio? The minimum requirement under Basel III is generally 3%. However, systemically important financial institutions (G-SIBs) often have higher regulatory expectations, sometimes ranging from 5% to 6% in certain jurisdictions. A ratio above the regulatory minimum indicates that a bank has sufficient Tier 1 capital relative to its total exposures. [^4^](https://www.ibm.com/docs/en/bfmdw/8.10.1?topic=accord-basel-iii-summary), [^5^](https://www.financialresearch.gov/the-ofr-blog/2024/08/02/banks-supplementary-leverage-ratio/)### Does the Basel III Leverage Ratio include off-balance sheet exposures? Yes, the Basel III Leverage Ratio's exposure measure includes [off-balance sheet items](https://diversification.com/term/off-balance-sheet-items) in addition to [on-balance sheet exposures](https://diversification.com/term/on-balance-sheet-exposures). These off-balance sheet items are converted into on-balance sheet equivalents using credit conversion factors. This inclusion was a key feature to prevent banks from obscuring leverage by shifting assets off their balance sheets.[^1^](https://www.bis.org/fsi/fsisummaries/b3_lrf.pdf), [^2^](https://www.bis.org/publ/bcbs270.htm), [^3^](https://www.financialresearch.gov/the-ofr-blog/2024/08/02/banks-supplementary-leverage-ratio/)