By James Kwak
The Basel Committee’s recent decision to change the definition of the leverage ratio is bad news for two reasons.
There’s the obvious: A smaller denominator means less capital. The leverage ratio requirement says, in principle, that banks must have capital equal to at least X% of their total unweighted assets, where “assets” is supposed to include anything they hold that could fall in value. Take some bank that has some amount Y of traditional assets and other things that could fall in value, like derivatives positions. Then it has to have capital equal to X * Y / 100. If we take the exact same bank but decide to call Y some smaller number, say Z, then it can get bay with less capital. Less capital = more risk.