Increase banks’ leverage ratio

Argumentation and justification

Prudential banking regulation, set by the Basel Committee agreements and transposed into regional and national legislation, aims to ensure the resilience of banks. In the wake of the 2008 crisis, the Basel 3 standards led to a tightening of prudential rules, but they remain insufficient.

Solvency ratio

One of the main prudential tools used to achieve the resilience of the banking sector is the solvency ratio. It aims ensures that banks hold sufficient capital to absorb losses (e.g. from borrower defaults).

The solvency ratio is made up of banks’ equity capital in the numerator and risk-weighted assets in the denominator.

This results, on the one hand, in great complexity (which bankers complain about, even though they are largely responsible for it) and, on the other hand, in great difficulty in monitoring. This is all the more so because banks are allowed to use internal models to calculate the risks to which they are exposed.

This tool was strengthened by the Basel 3 standards (the level of the ratio was raised and the possibility for banks to define risks themselves was limited), but the transposition into European law seems to fall short of ambitions, as financial regulators themselves admit.

The introduction of the leverage ratio in the Basel 3 standards

Bank capital must represent at least 3% of total assets (rather than risk-weighted assets). This ratio is therefore much simpler and much more robust (it is less manipulable, since it is not based on a risk assessment). The introduction of this new ratio is a step forward, but this threshold is far too low.

Banks weakened by insufficient capital represent a sword of Damocles for the economy as a whole. The European banking sector is still plagued by pockets of fragility that threaten the region’s overall financial stability and the public finances of member countries.

The stress tests carried out by the ECB and the European Banking Authority confirm this diagnosis, even if they cannot explicitly reveal major risks (due to the risk of mistrust and contagion this would create).

In early 2023, the collapse of Silicon Valley Bank in the USA and the UBS takeover of Crédit Suisse with the help of the public authorities showed just how fragile the biggest banks still are, despite the reforms that followed the 2008 crisis.

How this relate to global issues

• Financial instability increases uncertainty and thus the “tragedy of horizons”. ¹ i.e. the gap between the long-term horizon for the materialization of ecological risks such as climate change, and the short-term horizon of financial markets, which prevents them from properly integrating these risks into asset valuations.
• Financial crises reduce investment capacity, and therefore the investments that are essential for the ecological transition.
• The excessive power of systemic banks makes necessary (green) regulation difficult, and contributes to social injustice, which in turn hinders acceptance of economic transformation.
• This measure can be combined with a measure to weight funding (in the denominator) according to how ‘green’ it is.

Related works and supports for the measure

We list below a number of initiatives and publications that are consistent with the broad outlines of this proposal, i.e. strengthening banks’ leverage ratios. This does not mean that they endorse the details of what is set out here.

Rapport la finance aux citoyens, Secours catholique (2018)

Multimedia feature Bank capital, the resurrection of a myth, Finance Watch. See also their overall work on Banking Regulation

Banks bluff in a completely legal way the Committee for the Abolition of Illegitimate Debt (2013)

Between Debt and the Devil: Money, Credit and Fixing Global Finance, Adair Turner, Princeton University Press (2015)

Eviter l’effondrement, Jean-Michel Naulot, Le Seuil (2017)

The vulnerability of the global financial system, Pierre Cailleteau, Economica (2018)

La fascination de l’ogre, ou comment desserrer l’étau de la finance, Laurence Scialom, Fayard (2019)

How to dress up the bankLa Vie des idées, Jézabel Coubbey-Soubeyran (2013)

Let’s make a deal – speech by Robert Jenkins (2012)

The Bankers’ New Clothes. What’s Wrong with Banking and What to Do about It Princeton University Press, Anat Admati and Martin Hellwig (2013)

Pierre Durand, Gaëtan Le Quang, Banks to basics! Why banking regulation should focus on equity European Journal of Operational Research, (2021)

Legal and political feasibility

The measure is technically easy to implement.

Legally accessible without difficulty in France.

It has been and will continue to be the subject of an outcry from the banks, who argue that this measure reduces their return on equity, weakens them compared to US banks, and limits their ability to lend to the economy.

Other resources on The Other Economy

To better understand the technical aspects of this measure, we recommend the following readings.

In the modules:

• The money module covers the essentials of the institutional framework of money, as well as the power of banks to create money and the need to regulate it.
• The Role and Limits of Finance module

In the articles:

• Systemic banks
• Understanding a bank balance sheet
• Article on prudential regulation of banks – Basel Committee (forthcoming)

In the Resources” section, you’ll find a selection of books, reports and databases on banks and the monetary and financial system in general. In “Filter by theme” click on “Money, debt, finance”.