Definition
Leverage Ratio (Banking)
The banking leverage ratio is Tier 1 capital divided by a bank's total exposure, a non-risk-based backstop to the capital adequacy ratio.
Unlike CRAR, which weights assets by risk, the leverage ratio uses unweighted total exposure as the denominator. This prevents banks from appearing well capitalised simply by loading up on low-risk-weight assets. Under Basel III, the RBI sets a minimum leverage ratio for Indian banks.
The leverage ratio acts as a simple, hard floor on how large a balance sheet a bank can build on a given amount of core capital. It complements risk-based capital rules by catching cases where risk weights understate true exposure.
Related terms
- Capital Adequacy Ratio (CAR / CRAR)The Capital Adequacy Ratio, also called CRAR, is the ratio of a bank's capital to its risk-weighted assets, measuring its ability to absorb losses.
- Risk-Weighted Assets (RWA)Risk-Weighted Assets are a bank's assets weighted according to their credit risk, used as the denominator in capital adequacy calculations.
- Tier 1 CapitalTier 1 capital is a bank's core, going-concern capital, made up mainly of equity and reserves plus eligible additional Tier 1 instruments, that absorbs losses while the bank operates.
- Basel III NormsBasel III is the global bank regulation framework, adopted by the RBI, that strengthens capital quality, adds liquidity and leverage standards, and introduces capital buffers.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.