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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Basel III introduced a leverage ratio as a backstop to risk-based capital requirements. Which crisis observation most directly motivated this measure?

The leverage ratio was motivated by banks showing strong risk-based capital ratios while being heavily leveraged, since low risk weights on securitized assets masked balance sheet growth. A simple non-risk-weighted backstop limits excessive leverage regardless of modeled risk weights.

  1. ABanks reported high risk-based capital ratios while holding very large balance sheets relative to equity, because risk weights were low on securitized assetsCorrect
  2. BBanks held too little Tier 2 capital relative to Tier 1 capital
  3. CCentral banks lacked authority to act as lender of last resort
  4. DMark-to-market accounting forced banks to hold excessive liquid assets

Explanation

Many institutions showed strong risk-weighted ratios yet were highly leveraged, as low risk weights on securitized and trading assets allowed balance sheet growth. A non-risk-based leverage ratio limits this. The other options do not match the crisis evidence.

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