Banks will continue to be permitted to exclude central bank exposures from leverage-ratio calculations. Relief was first granted in September 2020 as part of ECB measures to help banks in reaction to the pandemic. The relief applies only to central bank exposures taken since end-2019. It was supposed to end this month. The extension occurs only days before the 3% leverage ratio for ECB-supervised banks becomes binding on 28 June 2021. Excluding central bank exposures from banks’ leverage ratios should be permanent.

The ECB noted that, based on year-end 2020 data of the 39 significant banks already excluding central bank exposures from their leverage ratio, the relief will increase average headroom over the required ratio by 50bp (ca. EUR 70bn in Tier 1 capital).

Given that the pandemic crisis is not over, central-bank and other public-sector support for the euro area’s economies is still needed, and banks’ effort to continue to lend to businesses and households remains essential. Other bank regulators should contemplate a similar extension of relief.

Banks had mainly used leverage ratios in the decades before the Basel risk-weighted capital standards. When international regulators decided to re-introduce a leverage ratio, in the aftermath of the global financial crisis, the rationale was to prevent banks from arbitraging existing capital rules through the excessive use of zero or low risk-weighted assets. For example, on or off-balance sheet exposures liable to generate market, credit and operational risks not being properly captured by existing capital metrics.

In Europe, prime candidates singled out for the new leverage ratio were institutions with significant wholesale and investment banking activities and which had outsized trading books by comparison to their banking books. Their US counterparts, which had all along remained subject to tougher capital and leverage regulations, on balance display more conservative leverage ratios.

So, from the angle of limiting and preventing large banks arbitraging risk-weighted capital rules, implementing a supplementary leverage ratio was fully legitimate, an overdue step in Europe which was lagging in this respect.

But it is difficult to argue that a European bank these days can arbitrage capital constraints by increasing its central bank exposure. Especially when there is little financial incentive to do so, at times of zero or negative remuneration on these exposures. The economic and supervisory purpose for including central bank exposures in the leverage ratio is simply not there. Credit risk is virtually non-existent, while market and operational risks are negligible – and anyway captured by different elements of the regulatory capital rules. In an ideal world, most banks would be happy to minimise non-remunerated central bank exposures.

By permanently eliminating central bank exposures from leverage ratio requirements, the value of this economic and supervisory ratio would increase, especially when looking at the gaps between it and risk-weighted capital ratios. With the lessons learned during the pandemic, the Basel Committee could do worse than re-visit this issue.