Leverage Ratio (Banking)

Risk-weighted capital rules depend on estimates of how risky different assets are. If those estimates are wrong, a bank could appear well capitalised while holding too little capital. The leverage ratio provides a simpler check that does not rely on risk weights.

It is calculated by dividing Tier 1 capital by the bank's total exposure, which includes its assets on the balance sheet and certain off-balance-sheet commitments, such as unused credit lines and derivatives.

For example, a bank with 40 million of Tier 1 capital and total exposures of 1,000 million has a leverage ratio of 4%.

International standards require banks to maintain a minimum leverage ratio, commonly 3%, with higher requirements for the largest banks in some countries. Because every asset counts equally, the ratio stops banks from building up very large holdings of assets that carry low risk weights but could still cause losses. Regulators use the leverage ratio alongside risk-based capital ratios to give a more complete picture of a bank's strength.