Garnet Capital Advisors Blog

April 8, 2014

Focus on leverage ratio could spur risky loan sales

Banks across the U.S. have been focusing on the leverage ratio, and complying with this particular requirement could motivate them to make loans that they consider safer or have lower capital requirements. 

In addition, financial institutions might seek to engage in loan sales of their riskier assets in an effort to shore up their existing portfolios. Banks might suffer lower earnings as a result of making such a move, as holding these higher yielding, riskier assets provides significant interest income.

Lenders might face greater pressure to take part in these transactions if government regulators approve some proposals that are on the table.

Both the Federal Deposit Insurance Corp. and the Federal Reserve Board planned to vote on a stricter leverage ratio for the largest lenders on April 8, according to American Banker. These two organizations, as well as the Office of the Comptroller of the Currency, planned to vote on a measure that would change how banks calculate the leverage ratio.

The move by many countries to adopt the Basel III capital requirements has played a big role in motivating U.S. regulators to determine the leverage ratio they will use, Reuters reported. International regulators provided revised methods for calculating this ratio in January 2014.

Oliver Ireland, who was previously an associate general counsel at the Fed and now works as a partner at law firm Morrison & Foerster, told the news source his concerns about how the proposal could impact lenders.

"There's a real risk here," he stated, according to the media outlet. "On one level, you're restructuring the market in ways that people don't understand or you're restricting banks' balance sheets in a way that people don't understand."