My hon. Friend is spot on. A bank’s leverage is the ratio of its assets to its equity capital. Its equity is equal to the value of its assets minus the value of its liabilities. A higher leverage ratio magnifies returns because any growth in the assets will be proportionally greater if equity is thin. The corollary, however, is that any losses are also magnified if leverage is greater. Such a bank’s equity can be wiped out by a smaller shock than would wipe out the equity of a less leveraged institution.
Vickers recommended a 25:1 leverage ratio for systemically important banks—in other words, 4% of equity capital—but the Chancellor has dismissed that proposal. The parliamentary commission says that it is “not convinced” by the Government’s decision to reject Vickers’ recommendation to limit leverage in that way, and that it
“considers it essential that the ring-fence should be supported by a higher leverage ratio, and would expect the leverage ratio to be set substantially higher than the 3% minimum required under Basel III.”