Industry Groups Call on Regulators to Exclude Client Collateral in Calculating Leverage Ratio
A broad coalition of industry groups urged regulators to exclude client collateral when calculating the total assets of banks, and argued that an unchanged leverage ratio would "reduce access to clearing and undermine one of the main goals of financial reform." The industry groups made these points in a written response to FDIC Vice President Thomas Hoenig's article, "Weakening Leverage Ratio Undermines Banks' Accounting." The industry groups asserted that Mr. Hoenig's commentary on the Basel Committee's leverage ratio contained "some flaws in its application to cleared derivatives," and warned that these flaws threatened to (i) "undermine global efforts to bring more derivatives into central clearing," (ii) "damage the health of the clearing ecosystem" and (iii) "make it more difficult for investment managers, commodity producers and other customers to hedge their risks."
The industry groups argued that the leverage ratio should rely on existing market regulations to "recognize segregated client margin as reducing the bank's actual economic exposure," instead of on the "current construct [that] fails to consider existing market regulations that mitigate such losses."
The industry groups expressed their shared concern that, "left unchanged, the leverage ratio will undermine recent financial regulatory reforms by driving banks out of the clearing business, thereby reducing access to clearing and limiting hedging opportunities for end users." They also stressed that maintaining the current leverage ratio could result in potential harm to "farmers seeking to manage commodity price fluctuations, commercial firms wishing to lock in prices as they distribute their goods, and pension funds using derivatives to enhance workers' retirement benefits."
Commentary
The industry groups set forth the straightforward proposition that segregated collateral cannot be deemed to be an asset on which a bank is able to leverage. If Vice Chair Hoenig has a different theory on the matter, then he should provide a specific explanation of how such collateral can be used to provide leverage to banks.
Additionally, the Vice Chair's remarks reflect a fundamental problem with bank regulators' policy: imposing more capital and leverage requirements does not make the financial system safer as a whole, even if an individual bank seems safer because of them. Unfortunately, by penalizing hedging transactions with capital requirements that are not tied to actual economic risk, the bank regulators are discouraging such transactions, which adds greater risks to the economy.