Wednesday, July 30, 2008

Bank regulators can't agree on leverage calculation

(FT) Like drunken sailors on a stormy sea, bank regulators and investors long for solid ground. Both will feel sure-footed only when capital positions are beyond danger and there are no more surprises like Monday’s cash grab by Merrill Lynch. Unfortunately, few agree on what “solid” is. US regulators prefer to view leverage as defined by a bank’s tangible equity versus total assets. In the UK and Europe, tangible core equity – which strips out forms of hybrid equity – tends to be measured against risk weighted assets.

Switzerland, however, is considering stricter targets based on the US concept of pure leverage. The regulator knows the importance of banking to the economy and never wants to see a UBS-style crisis again. Other European regulators are unlikely to follow suit, but investors remain concerned because UK and European banks look far less healthy than US peers on this measure. For example, the leverage ratios for UBS, Barclays and Société Générale are down to about 2 per cent. That is less than half the level for Bank of America and JPMorgan.

Leverage* at Europen and US banks is not leagues apartYet comparisons fail to consider accounting differences. Under IFRS standards, European balance sheets include securitised assets, conduits and structured investment vehicles – US GAAP ledgers do not. European banks also gross up their derivative exposures and carry insurance assets and a higher proportion of repo lending. Morgan Stanley reckons that after adjusting for these quirks, capital ratios become closer on both sides of the Atlantic.

However calculated, regulators want more capital. The Swiss Federal Banking Commission is supposedly considering a minimum leverage ratio of 5 per cent. Even on the more generous US GAAP approach, UBS, for example, would have to halve its dividend and sell SFr400bn of assets to hit that target by 2010, according to Morgan Stanley. Not that US banks can breathe easy. If regulators move to a 4 per cent floor, Citigroup would hypothetically have to cut its dividend by 75 per cent or reduce assets by a quarter. As sailors find, life on land can sometimes be tough.

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