Which of the two ratios binds first depends on the kind of risks that banks are running. The leverage ratio automatically places tighter limits on expansions in the balance sheet through supposedly low-risk assets. The international community has made progress on the leverage ratio. The definition guiding how it should be calculated was agreed at the start of this year. This will provide the basis for banks to disclose the ratio over the next 3 years in the light of which the international community will decide in 2017 on the calculation of a minimum standard. A number of authorities, including the US, the Netherlands, and the Swiss, have already introduced or are considering a leverage ratio in advance of the international standard. In the UK, the Prudential Regulation Authority has already asked the eight major UK banks and building societies to take steps to achieve a leverage ratio above 3%. The Financial Policy Committee has been asked by the Chancellor to review whether a leverage ratio framework should be introduced in advance of the international framework. This could include a power for the FPC to vary the ratio to counter macro-prudential risks. The FPC will consult on the review and expects to publish its conclusions towards the end of the year. There is also important work underway to ensure the risk-weighted framework is robust. Reviews are underway to build a credible standardised approach to calculating risk-weights for banks’ trading activities and their loan books; this too should help reduce the system’s exposure to model risk.
This is precisely what happened to both Lloyds Banking Group and Bank of America, which required large public capital injections after they made their acquisitions. If no suitable purchaser could be found, the choice for the authorities was between administration – for all or some of the business – or a taxpayer bailout. In a number of small and middle sized cases it was possible, without unacceptable disruption, to protect insured depositors by drawing on deposit insurance and, in some cases, public funds, while selling some parts of the business to another firm and putting the other parts of the business, including shareholders and subordinated debt, put into administration. Bradford and Bingley was the most notable example of this in the UK. But putting all or part of large institutions – especially large international ones – into administration proved impossible with one, notorious exception. And that exception, Lehmans, proved the rule that large, complex, systemic institutions were truly too big to fail. This should not have been a surprise. There was generally tough talk from regulators before the crisis. And there were some idiosyncratic isolated failures, like BCCI and Barings, which occurred outside a systemic crisis. But as a number of researchers have pointed out, large systemic institutions were able to raise debt on more favourable terms than smaller ones reflecting the perception – which turned out to be generally true – that investors in these institutions were protected by an implicit government guarantee.