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Requiring large UK banks to report leverage ratio daily will avoid ‘window dressing’, says PRA

Requiring the largest UK banks to report capital held as a percentage of on-balance sheet assets daily will prevent the financial stability measure being used as mere “window dressing”, the Prudential Regulation Authority (PRA) has said.13 Jul 2015

The term ‘window dressing’ is used by regulators to refer to the practice of banks “managing down” the value of their balance sheets around the reporting date, with the effect that their published leverage ratio figures are more flattering than they otherwise would be, the PRA said in a consultation paper outlining its proposed approach to leverage ratio reporting. For this reason, UK banks will be required to report an averaged figure, it said.

“As a non-risk sensitive measure, the leverage ratio is designed in such a way that it generally assigns equal weights to firms’ exposures and therefore is prone to the risk of period-end balance sheet management that improves firms’ leverage ratio positions temporarily,” the regulator, which is part of the Bank of England, said in its consultation paper.

“To enable the UK leverage ratio framework to be fully effective in promoting safety and soundness, it will be important to reduce incentives to engage in window dressing, to ensure that firms are meeting their leverage ratio requirements over time and to avoid instability in financial markets caused by transactions associated with window dressing. Therefore the PRA considers it desirable to introduce a rule to require firms in scope to report, alongside an end-period leveraged ratio, an averaged leverage ratio,” it said.

Acknowledging that a requirement to report daily averaged figures would potentially be “burdensome” for banks, the PRA said that this would only be in relation to on-balance sheet exposures. Banks would be able to use end-month average figures when reporting against off-balance sheet exposures, it said. Banks would be entitled to use “best estimates” when calculating the daily averaged components of the leverage ratio provided that they were measured “consistently and prudently”, it said.

The leverage ratio refers to the minimum level of capital banks have to hold as a proportion of their total assets without weighting for risk and is one of the measures of bank capital reporting required of global banks under the Basel III international regulatory regime. Global requirements are expected to come into force in 2018. Because it is a more straightforward calculation, the leverage ratio is considered less vulnerable to manipulation than traditional measures of the loans and other assets on banks’ balance sheets, such as capital or leverage ratios.

The PRA’s leverage ratio requirement is expected to apply to all banks and building societies it regulates which hold over £50 billion in retail deposits. It is due to come into force on 1 January 2016, with firms given a transitional period of 12 months to comply with the averaging requirement.

As previously announced, affected banks will be required to meet a minimum 3% leverage requirement under the PRA’s framework, as well as two additional buffers depending on the size and complexity of the firm and the relative strength of the economy. Firms that fall, or that threaten to fall, below the required ratio will be required to present a remedial plan to the regulator setting out how they intend to address the deficit.

The PRA is seeking views on its proposed reporting and disclosure requirements until 12 October.