Pillar 2 requirements for the risk of excessive leverage (P2R-LR)
Where, as a result of the risk of excessive leverage assessment, in accordance with Article 104a (3) and (4), of Directive 2013/36/EU, competent authorities determine P2R-LR to address this risk, they should add this requirement to the own funds requirement based on the leverage ratio as set out in Article 92(1), point (d), of Regulation (EU) No 575/2013 and not to the P1R based on the TREA as set out in Article 92(1), points (a) to (c). Competent authorities should consider the leverage ratio requirement and P2R-LR as a separate stack from the TREA-based requirements and P2R for all other types of risk (i.e. available own funds can simultaneously be used to meet requirements in the TREA-based stack and in the leverage ratio-based stack of own funds requirements).
7.3.1Assessment of risk of excessive leverage
In line with the concept of the leverage ratio (and its stack of requirements) as a backstop to the TREA-based own funds requirements, in the assessment of the risk of excessive leverage, competent authorities should focus on potential material vulnerabilities not covered or not sufficiently covered by the own funds requirements as set out in Article 92(1), point (d), of Regulation (EU) 575/2013 that may require corrective measures to the business activities of the institution, that were not envisaged in its business plan.
In assessing the risk of excessive leverage, competent authorities should consider all of the following aspects and adapt the depth of the assessment of each aspect in accordance with its relevance to the institution:
The elements of risk of excessive leverage that are considered not covered or not sufficiently covered by the leverage ratio own funds requirement set out in Article 92(1), point (d), of Regulation (EU) No 575/2013, as a result of, in particular:
regulatory arbitrage/optimisation of the leverage ratio by exchanging exposures counted in the leverage ratio for economically similar exposures that may be less counted in the leverage ratio exposure calculation;
regulatory arbitrage/optimisation by minimising the leverage ratio exposure in the form of temporary reductions in transaction volumes in key financial markets (particularly in the money market, in certain activities such as SFTs, but also in the derivative market) around reference dates, resulting in the reporting and public disclosure of elevated leverage ratios (‘window-dressing activities’);
specific features of the business model, business activities or other bank idiosyncrasies that either increase or decrease the extent to which the institution is exposed to the risk of excessive leverage, but are not covered or not sufficiently covered in the calculation of the leverage ratio. Competent authorities should consider, where applicable, high exposures to written options on equity or short positions via credit derivatives that may have an elevated exposure to peak losses, as these positions are not fully captured in the leverage ratio exposure (in contrast to, for example, written credit derivatives), and concentrations in certain off-balance sheet items where the idiosyncrasies inherent to the business activities of the institution may lead to increased volatility in drawdowns;
the elements of risk of excessive leverage that are explicitly excluded from or not explicitly addressed by the leverage ratio own funds requirement, including due to the exclusions listed in Article 429a of Regulation (EU) No 575/2013, particularly where there are concerns about the assessment of continued compliance with the conditions for these exclusions and where the reliance on a single exclusion is highly significant for the institution and the amount excluded is unduly volatile;
the changes in the institution’s leverage ratio and its components, including the foreseeable impact of current and future expected losses on the leverage ratio, taking into account the business model of the institution.
7.3.2Determination of P2R-LR
Competent authorities should determine the P2R-LR as the difference between the capital considered adequate to cover the risk of excessive leverage and the leverage ratio own funds requirements as set out in Article 92(1), point (d), of Regulation (EU) No 575/2013. This amount cannot be negative.
When setting P2R-LR, competent authorities should consider in particular:
elements of risk of excessive leverage that are considered not covered or not sufficiently covered by the leverage ratio own funds requirement set out in Article 92(1), point (d), of Regulation (EU) No 575/2013, particularly where the assessment of the aspects described in paragraphs 3255 and 326 indicate a high vulnerability when compared to the leverage ratio exposure;
elements of risk of excessive leverage that are explicitly excluded from or not explicitly addressed by the leverage ratio own funds requirement, including due to the exclusions listed in Article 429a(1), of Regulation (EU) No 575/2013, assessed in accordance with paragraph 3263, point b. Competent authorities should set P2R-LR only in those cases where particularly extensive use of a certain exclusion results in a level of leverage ratio that does not appropriately reflect the risk faced by the institution.
Competent authorities should identify, assess and quantify the risk of excessive leverage using the sources of information and methods set out in paragraphs 302 and 303, to the extent that they are relevant for this risk.
7.3.3Composition of P2R-LR
Competent authorities should add the P2R-LR to the minimum leverage ratio Tier 1 requirement. In order to meet this additional requirement, institutions should also be able to use any Tier 1 capital.
Where necessary, and having regard to the institutions’ specific circumstances, competent authorities may decide to require institutions to cover P2R-LR with a higher quality of capital than that specified in the previous paragraph. This decision should be clearly justified, highlighting the specific circumstances that led to it, taking into account the individual risk situation of the institution and considering situations where materialisation of the risk of excessive leverage may require a higher quality of capital to cover potential losses.