A ratio that relates a bank’s total debt to its equity/ capital or assets. Depending on the denominator, this ratio comes in multiple variations, including debt-to-equity ratio, debt-to-capital ratio, and debt-to-assets ratio:
Leverage ratio (debt-to-equity) = total debt / equity
Leverage ratio (debt-to-capital)= total debt / capital
Leverage can also be expressed in relation to a bank’s assets:
Leverage ratio= total debt / assets
In general, this ratio gives an indication of the solvency of a bank and the degree of its reliance on internal versus external sources of funding. The more leverage a bank has, the higher its potential to encounter solvency-related difficulties, which may in turn impair its ability to lend out money (its main source of business).
For example,if a bank lends 10 CU for every 1 CU of capital reserves, its capital leverage ratio is 1/10 or 10%. A leverage ratio of 5% indicates that a bank can lend 20 CU for every 1 CU its holds in reserves (1/20 or 5%).
