The Leverage Ratio

Banks that deal in derivatives must be able to explain how the treatment of each transaction changes the denominator of the leverage ratio. This comes up in regulatory reporting, collateral management, and derivatives data work.

What the rule requires

The capital adequacy ratio uses risk-weighted assets (RWA), which are assets multiplied by risk weights by asset type, as its denominator. Risk-Weighted Assets (RWA) covers the calculation. The leverage ratio was introduced as a simple measure that does not use risk weights, to limit the build-up of leverage in the banking system, and it complements the capital adequacy ratio¹.

$$\text{Leverage ratio} = \frac{\text{Tier 1 capital}}{\text{Exposure measure}}$$

The numerator, Tier 1 capital, is the sum of Common Equity Tier 1 (CET1) capital and Additional Tier 1 (AT1) capital². The denominator is called the "total exposure amount" in the notice. It is the sum of balance sheet assets, derivatives, repo-style transactions, and off-balance-sheet transactions³.

The Basel Committee on Banking Supervision (BCBS) announced the introduction of this requirement in December 2010 as part of Basel III. The framework was finalized in December 2017, and the definition of the denominator, including for derivatives, was revised⁴.

Basis and scope

The Financial Services Agency (FSA) is the competent authority. The basis is a notice issued pursuant to Article 14-2 of the Banking Act (FSA Notice No. 11 of 2019). Below, this notice is called "the notice." Bank holding companies have a separate notice with the same purpose⁵.

The rule applies to banks under the international standard, and falling below the required level triggers prompt corrective action¹. The main provisions of the notice are as follows³.

The articles of the notice cited in the text are based on the comparison table of the amendment draft that the FSA published on July 15, 2022. Later amendments after promulgation may not be reflected. Where the comparison table omits conditions on how derivatives are measured, the US rule is shown as an example.

What goes into the denominator

Total exposure is the sum of four amounts: on-balance-sheet assets, derivatives and similar transactions, repo and similar transactions, and off-balance-sheet transactions³. On-balance-sheet assets such as loans and securities are measured from total assets on the balance sheet, excluding assets related to derivatives and similar transactions and to repo-style transactions⁶. The amounts for derivatives and repo are measured under Articles 8 and 9, respectively³. Off-balance-sheet transactions are measured as the notional amount multiplied by a conversion factor for each transaction category⁷.

In the December 2017 finalization, the conversion factors for off-balance-sheet transactions were changed to use the factors of the standardized approach for credit risk as they are⁸.

How derivative exposure is measured

The amount for derivatives and similar transactions is calculated per netting set from replacement cost (RC) and potential future exposure (PFE). The December 2017 final document uses a modified SA-CCR and measures it with the following formula⁹. A netting set is a group of transactions under a legally effective bilateral netting agreement. Without such an agreement, each transaction is its own netting set¹⁰.

$$\text{Exposure} = 1.4 \times (RC + PFE)$$

The SA-CCR calculation itself is covered on the Overview of the Regulatory Treatment of Counterparty Risk page. The leverage ratio differs from the capital adequacy ratio in the following four points.

The first is the collateral that can be deducted from replacement cost. In the general case, only eligible cash variation margin can be deducted, and the notice uses the following formula¹¹.

$$RC = \max\{V - CVM_r + CVM_p,\ 0\}$$

$V$ is the total market value of the netting set, $CVM_r$ is the variation margin received in cash, and $CVM_p$ is the variation margin posted in cash. The more variation margin you receive, the smaller replacement cost becomes, and the more you post, the larger it becomes. However, only variation margin on transactions that meet all the conditions can be deducted. The only condition of the notice listed in the comparison table is that the currency of the cash exchanged is the same as the currency specified in the contract, and the other conditions are omitted¹². The following table shows the conditions of the US rule, which has the same purpose; it is not the content of the Japanese notice¹³.

Whether variation margin can be deducted from replacement cost is decided in the order shown in Figure 1.

Figure description

If any condition fails, the variation margin cannot be deducted in the general case. If all are met, then in principle the variation margin can be used as $CVM_r$ and $CVM_p$ in the formula. The exception for initial margin received from an indirect clearing member in client-cleared transactions is not covered by the figure and is described in a paragraph below.

Consider a hypothetical example in which Bank L has a netting set with a market value $V$ of 5 billion yen and a PFE of 1 billion yen, and has posted no variation margin, under three sets of terms. In Examples 1 and 2, assume the other conditions of the notice are met.

In Examples 1 and 3, the same amount of collateral is received, yet the derivative exposure is 8.4 billion yen, 3 times the 2.8 billion yen of Example 2. The exposure falls only when the currency and type of collateral match.

This is a separate numerical example from the one above. Consider a hypothetical example in which Bank L has a netting set with a counterparty. Market value $V$ is 12 billion yen, Bank L has received 10 billion yen of variation margin in cash, and the PFE is 3 billion yen. The derivative exposure is 7 billion yen if the conditions are met, and 21 billion yen (3 times) if they are not. The breakdown is in the following table.

Also, in the general case, collateral other than cash variation margin does not reduce replacement cost. Reductions in exposure from initial margin and variation margin are not recognized, except for the exception for cash variation margin⁹. As an exception, initial margin received from an indirect clearing member in client-cleared transactions can be taken into account in calculating the exposure to the indirect clearing member if it is appropriately segregated¹⁴.

The second is the PFE multiplier. In the SA-CCR for the capital adequacy ratio, the PFE multiplier can take a value of 1 or less. PFE becomes smaller when market value is below the collateral amount (when market value is negative, or when collateral exceeds market value)¹⁵. The leverage ratio notice sets this multiplier to 1, except for exposures to indirect clearing members in client clearing, and uses the sum of add-ons as PFE as it is. For interest rate derivatives, the add-on is calculated by multiplying a notional amount adjusted for duration and other factors by a supervisory factor¹⁶.

The third is sold credit derivatives. For a credit derivative on which the bank has sold protection, the notional amount is added to the denominator in addition to replacement cost and PFE¹⁷. However, except where the offset against purchased protection is used to determine the notional amount, sold credit derivatives can be excluded from the netting set used to calculate PFE¹⁸. If there is purchased protection, it may be deducted from the notional amount. For example, when the reference obligation is a single obligation, purchased protection qualifies only if it meets three conditions. The reference entity is the same as for the protection sold. The seniority is the same or subordinate. The remaining maturity is the same or longer¹⁹. If the creditworthiness of the protection seller and that of the reference entity are highly correlated, no offset is allowed²⁰.

The fourth is clearing. Consider the case where a clearing member passes a client's (indirect clearing member's) transactions to a qualifying central counterparty. There are two directions of guarantee. If the clearing member does not guarantee the clearing house's performance to the client, the exposure to the clearing house can be set to zero. If the clearing member guarantees the client's performance to the clearing house, it measures the exposure to the client, and if it does not, the exposure is zero²¹. The December 2017 final document said it would monitor the effect of the rules on clearing and complete its review within two years of finalization²².

Minimum level and add-ons

The internationally agreed minimum is 3% for all banks²³. Japanese banks under the international standard follow the levels and timeline below as of October 2026¹.

The G-SIB buffer adds, in Tier 1 capital, 50% of the G-SIB buffer in the capital adequacy ratio rules. If the G-SIB buffer in the capital adequacy ratio rules is 1%, the leverage ratio add-on is 0.5%. Falling below the add-on level restricts distributions of capital²³. The notice provides that the consolidated leverage ratio minus 3% must be at least the G-SIB buffer multiplied by 0.5²⁴.

Differences from the US supplementary leverage ratio

The US Board of Governors of the Federal Reserve System (FRB) sets a supplementary leverage ratio (Tier 1 capital divided by total leverage exposure) in 12 CFR Part 217²⁵.

In the US, balance sheet assets are measured as the daily average over the reporting quarter, and off-balance-sheet transactions as the average of the month-end amounts over the previous three months²⁵. A clearing member that does not guarantee the clearing house's performance on transactions it clears for clients can exclude the exposure to the clearing house²⁷. The Japanese notice has a provision with the same purpose, distinguishing treatment by whether there is a guarantee.

Where it constrains capital

Which of the capital adequacy ratio and the leverage ratio binds first depends on what share of total exposure the risk-weighted assets represent. The minimum Tier 1 ratio under the international standard is 6%²⁸. Compared with the Japanese leverage ratio minimum of 3.15%, this means that at a bank whose risk-weighted assets are less than 52.5% of total exposure ($3.15 \div 6$), the leverage ratio requires more Tier 1 capital. This is a rough guide that excludes buffers.

Consider a hypothetical example in which Bank L (not a G-SIB) has Tier 1 capital of 2.4 trillion yen and risk-weighted assets of 30 trillion yen. If total exposure, excluding deposits at the Bank of Japan, is 75 trillion yen, the results are as follows.

In case A, the Tier 1 capital required by the 6% minimum Tier 1 ratio is $0.06 \times 30 = 1.8$ trillion yen, and the amount required by the leverage ratio minimum is $0.0315 \times 75 \approx 2.36$ trillion yen. The leverage ratio requirement is larger and binds first. Case B falls below 3.15%. The shortfall is about 25.5 billion yen in Tier 1 capital terms, or about 0.81 trillion yen in total exposure terms. The upper limit of total exposure is $2.4 \div 0.0315 \approx 76.19$ trillion yen.

In trading, the denominator changes in the following situations.

• For transactions whose cash variation margin does not meet the conditions, replacement cost cannot be reduced. A currency that differs from the contract is one example.
• Initial margin and non-cash collateral do not reduce replacement cost in the general case. There is an exception for exposures to indirect clearing members in client clearing.
• In cleared transactions, the exposure can be set to zero if there is no guarantee. If there is a guarantee, the exposure to the client is also measured. The denominator therefore depends on whether there is a guarantee.

Practical implications

Notes

1. FSA, "バーゼル規制の概要" (Outline of Basel Regulations; our translation) (August 2026; in Japanese), page 6, "Leverage ratio." It shows the role of the ratio, its introduction, scope, prompt corrective action, the 3.15% minimum, and the G-SIB buffer levels. ↩ ↩² ↩³ ↩⁴

2. FSA, "バーゼル規制の概要" (Outline of Basel Regulations; our translation) (August 2026; in Japanese), page 4, "(1) Tier 1 capital." Tier 1 capital is divided into Common Equity Tier 1 (CET1) capital and Additional Tier 1 (AT1) capital. ↩

3. The notice, Article 6, paragraph 1 (the sum of the four amounts under Articles 7 to 10). FSA draft amendment (published July 15, 2022; in Japanese), comparison table, pages 6–7 (PDF pages 7–8). Article 4 (page 5) sets the numerator as the amount of Tier 1 capital. ↩ ↩² ↩³ ↩⁴

4. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (February 2018; in Japanese), page 3 (announcement of the introduction of the requirement in December 2010, and finalization of the framework in December 2017). The table of contents on page 2 shows the new definition of leverage exposure. ↩

5. The title of the notice is in the annex for banks (PDF page 1) of the comparison table (draft published July 15, 2022). The annex for bank holding companies is at https://www.fsa.go.jp/news/r3/ginkou/20220715/03.pdf (page 1). ↩

6. The notice, Article 7, paragraphs 1 and 2 (from total assets, exclude the amount of assets related to derivatives and similar transactions, the amount of assets related to repo-style transactions, and others). Comparison table, pages 7–8 (PDF pages 8–9). ↩

7. The notice, Article 10, paragraph 2, table (the notional amount of each category of off-balance-sheet transaction is multiplied by a conversion factor). Comparison table, pages 22–23 (PDF pages 23–24). ↩

8. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (in Japanese), page 9, "Off-balance-sheet (OBS) items." It uses the conversion factors of the standardized approach for credit risk and sets no floor on them. ↩

9. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (in Japanese), page 5, "Derivative exposure (adoption of the modified SA-CCR)." It shows the exposure under the modified SA-CCR, 1.4 x (RC + PFE), and the treatment of reductions from margin. ↩ ↩²

10. The notice, Article 8, paragraph 2 (definition of netting set). Comparison table, pages 11–12 (PDF pages 12–13). ↩

11. The notice, Article 8, paragraph 3, item 1, formula (RC = max{V − CVMr + CVMp, 0}). Comparison table, page 12 (PDF page 13). ↩

12. The notice, Article 8, paragraph 4 (CVMr and CVMp are limited to those related to derivatives and similar transactions that meet all the conditions), item 3 (the currency of the cash is the same as the currency specified in the contract for the derivatives and similar transactions). Comparison table, page 13 (PDF page 14). Items 1, 2, and 4 are shown as "omitted" in the comparison table. ↩

13. 12 CFR § 217.10(c)(2)(iii)(C)–(G). The five conditions in the table correspond to (C) to (G). They are set by the US rule and do not show the omitted conditions of the Japanese notice. ↩

14. The notice, Article 8, paragraph 3, item 2 (b) (exposures to indirect clearing members follow Article 79-2, paragraphs 2 to 5 of the capital adequacy ratio notice), paragraph 5 (initial margin can be taken into account only if appropriately segregated), and paragraph 7. Comparison table, pages 13–14 and 16 (PDF pages 14–15 and 17). ↩

15. The notice (FSA Notice No. 19 of 2006; full version updated August 24, 2026; in Japanese), Article 79-2, paragraph 6 (FSA full version, pages 192–193). PFE = multiplier x the sum of add-ons. The multiplier is min{1, 0.05 + (1 − 0.05) × exp(…)}. ↩

16. The notice (FSA Notice No. 19 of 2006; in Japanese), Article 79-2, paragraph 11 (FSA full version, pages 194–195). The add-on for interest rate derivatives is calculated by multiplying the effective notional amount by a supervisory factor, and the effective notional amount is the duration-adjusted notional amount multiplied by the supervisory delta and the maturity factor. ↩

17. The notice, Article 8, paragraph 1, proviso (the notional amount in item 3 is limited to credit derivatives and similar instruments on which the bank or others provide protection) and paragraph 2 (RC in item 1, PFE in item 2). Comparison table, page 11 (PDF page 12). ↩

18. The notice, Article 8, paragraph 8 (except where paragraph 9 is applied to determine the notional amount in paragraph 1, item 3, sold credit derivatives can be excluded from the netting set used to calculate PFE). Comparison table, page 16 (PDF page 17). ↩

19. The notice, Article 8, paragraph 9, item 1 (conditions where the reference obligation is a single obligation). Comparison table, pages 16–17 (PDF pages 17–18). ↩

20. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (in Japanese), page 7, "Credit derivatives." It shows offset conditions, such as no offset when the protection seller is highly correlated with the credit risk of the reference entity. ↩

21. The notice, Article 8, paragraph 3, item 2 (a) and item 3, and paragraph 6, items 2 and 3 (treatment where the bank, as a direct clearing member, transacts with both the indirect clearing member and the central counterparty). Comparison table, pages 12–15 (PDF pages 13–16). ↩

22. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (in Japanese), page 6, "Derivative exposure (client-cleared transactions)." It states that the effect on centrally cleared transactions will be monitored and the review completed within two years of finalization. ↩

23. FSA and Bank of Japan, "「レバレッジ比率の枠組みの見直し」の概要" (Outline of "Revisions to the Leverage Ratio Framework"; our translation) (in Japanese), page 4, "Minimum level and additional requirement for G-SIBs." 3% for all banks; for G-SIBs, 50% of the G-SIB buffer in the capital adequacy ratio rules is added in Tier 1 capital, and restrictions on capital distributions apply below it. ↩ ↩²

24. The notice, Article 2, paragraph 2 (the consolidated leverage buffer ratio is the consolidated leverage ratio minus 3%, and must be at least the ratio specified in Article 2-2, paragraph 5, item 1 of the capital adequacy ratio notice multiplied by 0.5). Comparison table, page 4 (PDF page 5). ↩

25. 12 CFR § 217.10(a)(1)(v) (3% supplementary leverage ratio for advanced approaches institutions and Category III institutions) and (c)(1) (Tier 1 capital divided by total leverage exposure; on-balance-sheet assets as the daily average over the reporting quarter, off-balance-sheet as the average of month-end amounts over the previous three months). eCFR as of September 30, 2026. ↩ ↩²

26. 12 CFR § 217.11(a)(2)(v)(A) (for a G-SIB holding company, the leverage buffer is 50% of the method 1 surcharge) and (B) (for a bank subsidiary, the smaller of 1.0% and 50%). eCFR as of September 30, 2026. ↩

27. 12 CFR § 217.10(c)(2)(ix)(C) (a clearing member that does not guarantee the CCP's performance on transactions cleared for clients can exclude the exposure to the CCP. The rule refers to a CCP, with no qualification as to eligibility). ↩

28. The notice (FSA Notice No. 19 of 2006; full version updated August 24, 2026; in Japanese), Article 2, item 2 (FSA full version, page 27). The consolidated Tier 1 ratio must be at least 6%. ↩

29. FSA, "バーゼル規制の概要" (Outline of Basel Regulations; our translation) (August 2026; in Japanese), page 20, "Main disclosure items and frequency." The leverage ratio is an item required of financial institutions under the international standard, disclosed quarterly. ↩