Risk weights or leverage ratio? We need both

The two chopsticks in this analogy, which I initially made at a recent conference, are the simple leverage ratio — core capital divided by assets — and the more complex risk-weighted capital calculations. Much of the discussion around capital requirements is which of the two measures is preferred, as well as which measure should be the standard for an adequate capital base.
But this shouldn’t be an “either or” debate. The banking system ultimately needs a balanced approach to capital, which allows banks to efficiently function while also maintaining financial stability. Apply only one capital measure — it doesn’t matter which one — and the capital system will eventually flop.
Advocates for either the leverage ratio or risk-weighted measures often fail to appreciate this need for balance. Hence the regulatory debate too often consists of people on both sides embracing a one-chopstick approach.

Aaron Klein

American Banker

December 20, 2017

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