Thursday, 25 June 2015

NO.2 – TOTAL ASSETS, EQUITY AND LEVERAGE IN THE BANKING SYSTEM



  
A financial economist, June 2015

Methodological note: leverage is a measure of debt in relative terms (as compared to own resources). For the purpose of this column, bank leverage is defined as total assets over equity. Leverage is not a risk-sensitive measure as it does not differentiate among assets of different quality. Basel III agreement includes a prudential leverage ratio. The leverage ratio has been transposed into EU regulation as part of the CRD IV package. A leverage cap should become a binding requirement as of 1 January 2018. The leverage ratio presented in this column is only a proxy for the prudential leverage ratio as it relies on total own funds (instead of common equity tier 1) and does not take into account off balance sheet items.


1. Introduction


This column analyses the evolution of total assets, equity and its relation (the leverage ratio) for the banking system in a selection of EU countries. These are three basic measures of the risk undertaken by the banking system: total assets measure the overall exposure of banks and equity indicates how much of that exposure is backed by the bank's owners. These two measures in absolute terms are complemented by the leverage ratio as a relative measure which indicates how many times total assets exceed equity.


2. Euro area aggregates


From 2000 to late 2008, average euro area leverage ratio remained roughly stable between 17-to-1 and 18-to-1. The global financial crisis triggered a steady reduction in the leverage of banks, driving the leverage ratio down to almost 12-to-1 by early 2014. Thereafter leverage ratio has slightly increased. The euro area aggregate may conceal significant disparity across individual countries, the other sections enter into the country-by-country details.

Chart 1: Total assets, equity and leverage in the euro area banking system
Leverage ratio (total assets to total equity)
Volume (€ bn)                                         Index: 2006 = 100
Note: Leverage ratio is calculated with available data (total assets and equity as reported in monetary statistics) and it does not correspond to a specific definition in regulatory requirements.
Source: European Central Bank and own calculations.


The reduction in euro area leverage is the result of two effects. On the one hand, bank equity has constantly expanded, with a total increase of over €1,500 billion since January 2000 or of almost €700 billion since September 2008 (when Lehman Brothers failed). This increase in capital during the crisis reflects public injections, capital obtained from private sources and retained earnings. On the other hand, total assets have stagnated since 2008 as a consequence of recognition of impaired assets and the need to reduce excessive leverage accumulated in the run up to the crisis.


3. Country breakdown: Total assets


In the initial years of the crisis, total assets continued to expand in some countries. Since mid-2012, data show a generalised decline in total assets with very few exceptions. However, by late 2014, total assets still remained above pre-crisis levels in most countries except in countries like Ireland, Luxembourg, Belgium and the UK where significant declines in total assets led to banks' balance sheet of a similar size or even smaller than prior to the crisis. In the last few months, a divergent evolution is observed between some countries (e.g. program countries, Spain, Italy and Romania) with assets still declining or stagnated; and other countries (e.g. core countries, the UK and Poland) where total banking assets started to expand again.

Chart 2: Total assets of EU banks (index: 2006 = 100)
Program countries                                         Belgium, Italy, Austria, and Spain

Core countries                                         Non-euro area countries
Source: European Central Bank and own calculations.


4. Country breakdown: Equity


Since the outbreak of the crisis, low capital levels in some banks have been pointed out as one of the weaknesses jeopardising the confidence in EU banks. The EBA undertook stress tests in 2010 and 2011 followed by a recapitalisation exercise in 2012-2013. Moreover, the ECB undertook a comprehensive review (including an asset quality review and stress test) ahead of taking its new supervision responsibilities in late 2014. The ECB exercise ran in parallel with a new round of EBA stress test, which included euro area and non-euro area countries. These supervisory exercises and the market pressure pushed banks to increase their levels of equity.

Data show indeed how banks across EU countries increased their equity during the crisis. In relative terms, the highest increases in equity are observed in Ireland, Greece, Spain and Romania. In Ireland, a reversal in the evolution of the total amount of equity in the banking system is observed since late 2012. The drop observed in Romania and Hungary in early 2015 is probably linked to the losses stemming from loans in foreign currency following the revaluation of the Swiss franc after the Swiss central bank stopped its peg to the euro. The drop observed in Spain in late 2014 is probably linked to accounting effects and valuation adjustments. The downwards spike observed in Greece in 2012 is linked to the "private sector involvement" (under which bond holders accepted to take a haircut on Greek government debt) and the subsequent recapitalisation of Greek banks. Except in a few countries, the expansionary phase of equity seems to have come to an end in the last few months.

Chart 3: Total equity (capital and reserves) of EU banks (index: 2006 = 100)
Program countries                                         Belgium, Italy, Austria, and Spain

Core countries                                         Non-euro area countries
Source: European Central Bank and own calculations.


5. Country breakdown: Leverage ratio


The previous two sections show that, in most countries, total assets have declined while equity kept expanding. The combination of those two factors leads to a generalised decline in leverage across EU countries. Nevertheless, there is still a significant dispersion in the leverage of banks across countries. With a leverage ratio of 20-to-1, the Netherlands is the country with the most leveraged banks. In countries like Germany, Luxembourg, Belgium and France, banks operate with a leverage ratio between 15-to-1 and 20-to-1 (all above the euro area average). In countries like Ireland, Italy, Austria, Spain, the UK and Hungary banks operate with a leverage ratio around 10-to-1. Finally, countries like Greece, Cyprus and Romania operate with the leverage ratios as low as 5-to-1. The evolution of the leverage ratio reflects the evolution of its components (total assets and equity) including the various jumps and spikes observed in the series for equity.

Chart 4: Leverage ratio (total assets to total equity) of EU banks (number of times)
Program countries                                         Belgium, Italy, Austria, and Spain

Core countries                                         Non-euro area countries
Note: Leverage ratio is calculated with available data total assets and equity as reported in monetary statistics) and it does not correspond to a specific definition in regulatory requirements.
Source: European Central Bank and own calculations.





Annex: Additional charts



Chart A1: Leverage ratio (total assets to total equity) of EU banks (number of times), April 2015
Note: Leverage ratio is calculated with available data (total assets and equity as reported in monetary statistics) and it does not correspond to a specific definition in regulatory requirements.
Source: European Central Bank and own calculations.

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