Additional own funds requirements for the risk of excessive leverage
In accordance with Article 104a (3) and (4) of Directive 2013/36/EU(40), competent authorities should assess the risk of excessive leverage separately from other types of risk. Where, as a result of such an assessment, competent authorities determine additional own funds requirement to address the risk of excessive leverage, 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 own funds requirements based on the total risk exposure amount (TREA) as set out in points (a) to (c) of that paragraph of the article. Competent authorities should consider the leverage ratio requirement and the additional own funds requirement to address the risk of excessive leverage as a separate stack from the TREA-based requirements and additional own funds requirements 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 as defined in Article 4(1), point (93) and (94) of Regulation (EU) No 575/2013, 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 they should adapt the depth of the assessment of each aspect depending on its relevance for the institution:
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 of transaction volumes in key financial markets (particularly in the money market, of certain activities such as SFTs, but also in the derivative market) around reference dates resulting in the reporting(41) and public disclosure of elevated leverage ratios (‘window-dressing activities’); and
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 (e.g. as per the aspects in paragraph 393) 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.
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 additional own funds requirement to address the risk of excessive leverage
On the basis of the assessment performed under Section 7.3.1 of these Guidelines, competent authorities should determine the additional own funds requirements to address the risk of excessive leverage 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 additional own funds requirements to address the risk of excessive leverage 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 393 or 394 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 394b. Competent authorities should set additional own funds requirements 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 ensure that the capital considered adequate to cover the risk of excessive leverage is not lower than the leverage ratio own funds requirements (i.e. the additional own funds requirements to address the risk of excessive leverage cannot be negative).
Competent authorities should identify, assess and quantify the risk of excessive leverage following the sources of information and methods set out in paragraphs 370 and 371, using the available sources of information to the extent that they are relevant for the risk of excessive leverage.
7.3.3Composition of additional own funds requirement to address the risk of excessive leverage
Competent authorities should add the additional own funds requirement to address the risk of excessive leverage 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 specific circumstances of an institution, competent authorities may require institutions to cover additional own funds requirements with a higher quality of capital than that referred to in paragraph 399. Any imposition of a higher quality of capital should be justified, 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.