1.Risk-based capital adequacy ratios measure the extent to which a bank has sufficient capital relative to the risk of its business activities. They are based on a foundational principle: that a bank that takes higher risks should have higher capital to compensate.

2.Leverage, on the other hand, measures the extent to which a bank has financed its assets with equity. It does not matter what those assets are, or their risk characteristics. The leverage ratio, by placing an absolute cap on exposures relative to a bank’s capital, is an important component of the Central Bank capital framework, and complements the risk-based capital adequacy regime. However, neither of these parts of the framework stands alone: it is important to look at Central Bank capital requirements as a package of constraints that mutually reinforce prudent behaviour. Even though the leverage ratio has been designed as a backstop, it must be a meaningful backstop if it is to serve its intended purpose.

3.One of the underlying causes of the global financial crisis is believed to have been the build-up of excessive on- and off-balance-sheet leverage in the banking system. At the height of the crisis, developments in financial markets forced banks to reduce leverage in a manner that likely amplified downward pressures on asset prices. This deleveraging process exacerbated the feedback loop between losses, falling bank capital, and shrinking credit availability.

4.The Central Bank’s leverage ratio framework introduces a simple, transparent, non-risk-based leverage ratio to act as a credible supplementary measure to the risk-based capital requirements. The leverage ratio is intended to:

•restrict the build-up of leverage in the banking sector to avoid destabilizing deleveraging processes that can damage the broader financial system and the economy; and

•reinforce the risk-based requirements with a simple, non-risk-based “backstop” measure.

5.The Basel Committee on Banking Supervision (BCBS) adopted the leverage ratio with the launch of Basel III in December 2010. A revised leverage ratio framework, titled Basel III Leverage Ratio Framework and Disclosure Requirements, was published in January 2014. In December 2017, the leverage ratio was finalized along with the rest of the Basel III capital framework. Prior to each release of the leverage ratio, the BCBS published consultative documentation and sought comments from the industry. Additionally, in 2015 and 2017, the BCBS published revised Pillar 3 disclosure requirements, including updated disclosure requirements for the leverage ratio.

6.In designing the UAE leverage ratio framework, the Central Bank considered the full evolution of the BCBS leverage ratio, including consultative frameworks, reporting requirements, and comments raised by banks and industry bodies across the globe. The Central Bank’s Standards for Leverage Ratio is based closely on the requirements articulated by the BCBS in the document Basel III: Finalising post-crisis reforms, December 2017.

7.This Guidance should be read in conjunction with the Central Bank’s Standards on Leverage Ratio, as it is intended to provide clarification of the requirements of that Standards, and together with that Standards supports the Central Bank’s Regulations Re Capital Adequacy.