The one-size-fits-all approach from the Basel Committee on Banking Supervision has, inevitably, run into various challenges. Not surprisingly from London where Mark Carney, Governor of the Bank of England.
On the one hand Mr Carney would like to make it easier for smaller ‘challenger’ banks to lend to the ‘small to medium enterprise’ (SME) sector while on the other he sees the clear imperative to make appropriate arrangements to address issues relating to the ‘systemically significant’ institutions (or in other words the ‘too big to fail’ banks) .
But as Governor Mr Carney has also some responsibilities relating to the economy in general, and inflation in particular. His comments on a housing bubble underscore how the scope of the BoE Governor’s responsibilities has widened significantly in recent years.
Macro and micro prudential analysis is now taken as the principal means by which future financial crises will be anticipated and contained. Put simply, it means to ascertain whether individual institutions, groups of institutions and the system as a whole have enough capital and liquidity.
If stress testing (of individual institutions, groups of institutions, and the system as a whole) indicates a potential shortage then the Governor can call for additional capital or liquidity for the relevant institutions.
But Mr Carney now appears inclined to call for additional capital to restrict property based lending and thus avert yet another property bubble. Perhaps he does not wish to be seen to be announcing a rate rise.
Returning to Basel, the original Accord was agreed in 1988 by the Basel Committee on Banking Supervision (first convened in 1974) under the aegis of the Bank for International Settlements (BIS). The 1988 Accord, now referred to as Basel I, was based on the so called ‘cash ratio’ (capital to loans) which evolved to the RAR – the ratio of capital to risk weighted assets. This accord was amended in 1996. The amendment made a distinction between the banking book and the trading book. All this was aimed at maintaining the stability of the international banking system. It took effect for EU banks via BCD (the Banking Co-ordination Directive).
The ‘new’ accord (Basel II) mooted in 1999 and issued in 2004, purported to ensure that the financial resources held by a firm better reflect the risks associated with the firm’s business activities and its risk management arrangements. Notably it introduced the idea of operational risk (in addition to market and credit risk).
The capital requirements most recently set out by the Basel Committee (Basel III):
• Common Equity Tier 1 must be at least 4.5% of risk-weighted assets at all times.
• Tier 1 Capital must be at least 6.0% of risk-weighted assets at all times.
• Total Capital (Tier 1 Capital plus Tier 2 Capital) must be at least 8.0% of risk weighted assets at all times.
Additional requirements include:
• a countercyclical buffer
• more rigorous credit analyses of externally rated securitisation exposures.
• significantly higher capital for trading and derivatives activities
But London with its range and scope of financial business, greater than that of any other financial centre, perhaps deserves a more nuanced approach than ‘one size fits all’.
This greater range and scope of business is in part due to the time zone it is located in: London based firms can trade in the morning the Far-East (where it would be afternoon) and in the afternoon trade with the American time zone (where it would be morning).
But this breadth of business is also due in part to its history: the City of London is over 800 years old and it origins date back to the Roman conquest of Britain AD43. During the Middle Ages London became a large shipping hub with many wealthy merchants. These merchants use their wealth to provide finance.
Following the advent of the joint stock company in the seventeenth century, the City became a burgeoning financial and commodity marketplace. Names of City streets such as Bread Street, Milk Street and Fish Street Hill indicate the natures of these markets. The City’s reputation and integrity are encapsulated in its unofficial motto ‘my word is my bond’. From this evolved the modern markets, supporting infrastructure and skilled workforce drawn from wider than the UK, which we see today.
Perhaps what is required is for the UK to engage more with the Basel Committee, say by providing technical experts free of charge, so that proper analysis is undertaken before inappropriate one-size-fits-all policy is drafted.
If this is true for our dealings with the Basel Committee, it is even more relevant for our dealings with the various European institutions affecting financial regulation going forward, such as the European Commission and various supervisory authorities like the EBA, ESMA and EIOPA.
Ranil Perera is a director of Regulation and Risk Ltd, a financial services risk and regulatory compliance contracting firm