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S&P Global Market Intelligence: Leverage ratios underscore challenge of Basel’s risk-weight proposals

European banks are generally well-capitalized under their favored risk-weighted approach, but leverage ratios show the scale of the potential challenge from the Basel Committee’s latest proposals.

Large yet ostensibly low-risk mortgage books mean that Swedish lenders, for example, have high common equity Tier 1 ratios, which are based on risk-weighted assets, but relatively weak leverage ratios, which are based on total assets.

Relative to U.S. peers, European lenders demonstrate generally lower leverage ratios, as U.S. banks benefit from differing treatment of off-balance-sheet exposures, the transfer of mortgage exposure to government-sponsored Fannie Mae and Freddie Mac and the tendency of U.S. corporations to fund themselves in the capital markets.

Unsurprisingly, European banks prefer the risk-based approach to measuring capital strength and largely consider the leverage ratio "a backstop" to the CET1 ratio. The European Banking Authority requirement is at 3% and widely expected to rise to 4%.

With a handful of exceptions, the major European banks already exceed the 4% threshold. Yet they face further pressure as the Basel Committee weighs changes to risk-weighting rules, including minimum weights for mortgage lending.

In addition to the Swedish banks, Dutch lenders including ABN AMRO Group NV could struggle here. Loan-to-value ratios on Dutch mortgages are the highest in the eurozone, leaving them highly exposed to potential risk-weighting changes. ABN AMRO reported a leverage ratio of 3.7% at the end of the first quarter, yet has strengthened its capital notably during the past year and has one of the European cohort’s highest CET1 ratios.

Next Finance , June 2016

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