Financial Leverage Ratio

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New York Times  Mar 20  Comment 
The New York Fed president's concerns are said to have delayed a banking rule. | Questions about why seven Dewey & LeBoeuf employees who have pleaded guilty have not been identified. | The Federal Reserve is continuing to taper its bond-buying...
Euromoney  Jan 30  Comment 
Basel revisions dilute a key safeguard; bankers are celebrating.
Euromoney  Jan 15  Comment 
The recent loosening of rules regarding leverage ratios and collateral by the Basel Committee on Banking Supervision might boost banks’ available trading resources, but FX is not out of the regulatory woods.
Reuters  Dec 15  Comment 
Switzerland's plan to raise the leverage ratio required of banks is unrealistic, the chief executive of top Swiss bank UBS said in a newspaper interview published on Sunday.
Euromoney  Nov 26  Comment 
Why the UK - and European - bank-deleveraging cycle has much further to go, following George Osborne's call for the Bank of England to review leverage ratios.
Mondo Visione  Sep 24  Comment 
The Global Financial Markets Association (“GFMA”), American Bankers Association, Financial Services Roundtable, Institute of International Bankers, Institute of International Finance, and the International Swaps and Derivatives Association...
The Globe and Mail  Jul 12  Comment 
Watchdog’s calculations include outdated forms of capital
Mondo Visione  Jul 10  Comment 
SIFMA today released the following statement from Kenneth E. Bentsen, Jr., president, after the Federal Deposit Insurance Corporation approved a proposal to increase the leverage ratio for bank holding companies and insured depository...




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The Financial Leverage ratio equals total assets divided by total equity

The financial leverage ratio is a measure of how much assets a company holds relative to its equity. A high financial leverage ratio means that the company is using debt and other liabilities to finance its assets -- and, every thing else being equal, is more riskier than a company with lower leverage.

In essence, the financial leverage ratio is a variation of the debt to equity ratio and would move in tandem with debt to equity. If a company can employ its assets at a higher return than its cost of debt, it would improve its returns on equity capital. If not the company's debt outweighs the return from its assets, then the debt cost may outweigh the return on assets. Over the long-term, this would lead to bankruptcy. Investors should take this into consideration when investing in a company with a high financial leverage ratio, especially in times of rising interest rates.

The level of leverage depends on a lot of factors such as availability of collateral, strength of operating cash flow and tax treatments. Thus, investors should be careful about comparing financial leverage between companies from different industries. For example companies in the banking industry naturally operates with a high leverage as their assets are easily collateralized.

Example

  • Company XYZ has $4 billion in assets and $1 billion in equity. This would mean that it is financing its assets with $ 3 billion liabilities. And the the company's financial leverage ratio would be 4.
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