Supplementary Leverage Ratio SLR: The Non-Risk-Weighted Capital Backstop

Key Takeaways

• The SLR divides Tier 1 capital by total leverage exposure with no risk weighting, acting as a blunt backstop to the risk-based ratios.
• The US minimum is 3 percent; the enhanced SLR requires 5 percent at G-SIB holding companies and 6 percent at their insured depository subsidiaries.
• Because it ignores risk weights, the SLR often binds first for low-risk, low-margin books such as Treasuries, repo, and agency mortgages.
• A 2020 COVID exclusion of Treasuries and Federal Reserve reserves from the denominator was temporary and expired in March 2021.

What It Is

The SLR divides Tier 1 capital by a total leverage exposure that counts on-balance-sheet assets, most off-balance-sheet commitments, derivatives exposures measured under SA-CCR, and securities financing transactions (SFTs) at gross value with limited netting.

SLR = Tier 1 capital / Total leverage exposure

The US minimum SLR is 3 percent for advanced approaches banks. The enhanced SLR (eSLR) raises the bar for the largest US banks: G-SIB holding companies must hold 5 percent, and their insured depository institution subsidiaries must hold 6 percent to be considered "well capitalised" for prompt corrective action purposes. The international Basel leverage ratio minimum is also 3 percent, with a G-SIB buffer of 50 percent of the Higher Loss Absorbency requirement.

The Intuition

Risk-weighted capital ratios assume the risk weights are right. If the weights understate risk, the ratio looks comfortable even when the balance sheet is dangerous. The leverage ratio ignores risk weights entirely. It is a blunt backstop that says: no matter what your models tell you, total exposure cannot exceed a certain multiple of capital.

Banks whose businesses are dominated by low-risk, low-margin activity (US Treasuries holdings, repo market-making, agency mortgage inventory) will typically find the leverage ratio binds before the risk-based ratio. Banks weighted toward higher-risk lending find the risk-based ratio binds first.

How It Works

Total leverage exposure has four main components.

• On-balance-sheet assets. Most assets at their accounting value, including cash placed with central banks unless a temporary exclusion applies.
• Derivatives. Replacement cost plus potential future exposure, calculated under the Standardised Approach for Counterparty Credit Risk (SA-CCR). Variation margin in cash can reduce replacement cost subject to specific conditions.
• Securities financing transactions. Gross asset plus a counterparty credit risk add-on. Netting is limited to same-counterparty, same-settlement-date cash legs.
• Off-balance-sheet items. Conversion factors from 10 to 100 percent applied to commitments, guarantees, and letters of credit.

The Tier 1 numerator is the same as under the risk-based rules. The denominator is very different from RWA, because it does not scale with perceived risk.

During the COVID-19 stress of 2020, US regulators issued a temporary exclusion of Treasuries and reserves at the Federal Reserve from the SLR denominator to relieve balance sheet pressure in Treasury market-making. The exemption expired in March 2021. Proposals to refine the SLR treatment of Treasury exposures have continued to be discussed by the US agencies since.

Worked Example

Consider a US G-SIB holding company with:

• Tier 1 capital: 200 billion
• On-balance-sheet assets: 3,000 billion
• Derivatives exposure (SA-CCR): 400 billion
• SFT exposure: 500 billion
• Off-balance-sheet items (credit converted): 200 billion

Total leverage exposure = 3,000 + 400 + 500 + 200 = 4,100 billion
SLR = 200 / 4,100 = 4.88%

The bank is below the 5 percent eSLR well-capitalised threshold for a G-SIB holding company. It has three options: reduce the denominator (shed low-risk assets like Treasuries and reserves, compress SFT books), raise Tier 1 capital, or accept the restrictions that come with sitting in the buffer zone, including limits on capital distributions and bonuses.

Notice how a Treasury inventory, which carries a zero or very low risk weight under the risk-based rules, still costs the full dollar amount of leverage exposure. That is why SLR sometimes drives decisions that look odd from a risk-based lens, such as banks stepping back from Treasury repo in stress.

Common Mistakes

1. Reading SLR like a risk ratio. SLR does not care that Treasuries and cash at the central bank are low risk. A desk expanding Treasury inventory looks fine on RWA but consumes leverage capacity dollar-for-dollar.

2. Assuming the numerator matches the risk-based ratio exactly. Tier 1 is close but not identical across frameworks after all deductions. Transition arrangements and local deductions can cause small but meaningful divergences that show up in disclosed ratios.

3. Ignoring the interaction with repo market-making. In periods when balance sheet capacity is scarce, banks pull back from low-margin intermediation in the Treasury repo and financing markets. That withdrawal has shown up in US market volatility episodes (notably September 2019 and March 2020).

4. Treating SLR exemptions as permanent. The 2020 exclusion of Treasuries and reserves was explicitly temporary. Strategies or business cases built on the assumption that it would persist ran into a hard wall when the exemption lapsed in March 2021.

5. Ignoring the IDI-level eSLR. For US G-SIBs, the 6 percent requirement at the insured depository institution is usually tighter than the 5 percent holding-company number. Planning only against the parent ratio can leave the bank subsidiary in a worse position than the top of the house.

Frequently Asked Questions

What is the supplementary leverage ratio SLR in simple terms? It is Tier 1 capital divided by total leverage exposure, on-balance-sheet assets, derivatives, securities financing, and off-balance-sheet items, with no adjustment for risk. It caps how big a balance sheet can grow relative to capital.

How is the SLR different from risk-based capital ratios? Risk-based ratios weight assets by perceived risk, while the SLR ignores risk weights entirely. A dollar of Treasuries consumes the same leverage capacity as a dollar of high-risk lending.

What SLR levels must US banks meet? The baseline minimum is 3 percent. The enhanced SLR raises it to 5 percent at G-SIB holding companies and 6 percent at their insured depository institution subsidiaries to count as well capitalised.

Why does the SLR affect the Treasury and repo markets? Low-risk inventory consumes leverage capacity dollar-for-dollar, so banks pull back from low-margin Treasury repo and market-making when balance sheet is scarce, as seen in September 2019 and March 2020.

Was the SLR exemption for Treasuries permanent? No. The 2020 exclusion of Treasuries and Federal Reserve reserves from the denominator was explicitly temporary and expired in March 2021; later refinements have been discussed but not enacted.

Sources

1. Federal Reserve. "Regulatory Capital Rules: Regulation Q." https://www.federalreserve.gov/supervisionreg/reglisting.htm
2. Basel Committee on Banking Supervision. "Basel III leverage ratio framework and disclosure requirements." BCBS 270. https://www.bis.org/publ/bcbs270.htm
3. Office of the Comptroller of the Currency. "Enhanced Supplementary Leverage Ratio Standards." https://www.occ.treas.gov/news-issuances/federal-register/2014/79fr24528.pdf
4. FDIC. "Regulatory Capital Rules: Final Rule." https://www.fdic.gov/regulations/laws/federal/

Disclaimer

This article is educational content only and is not financial advice. Nothing here is a recommendation to buy, sell, or hold any security. Consult a licensed advisor before making investment decisions.