Yesterday on MB a post about the Australian banks being classified as D-SIBs under Basel III led to conversation about capital requirements of the Australian banking system and their use of internal modelling to determine their own capital requirements against assets. This is a topic our own Deep T has been covering for well over 2 years.
I’m not going to go into any detail on this topic in this post as this subject is horrendously wonkish and maybe only of interest to a few readers. It is, however, something that is fundamentally important when it comes to the financial stability of the Australian economy and also very educational if you are at all interested in banking and monetary functions. If you are new to the concept of “capital held against risk weighted assets” I recommend this post from Deep T to get you started.
In a somewhat timely release, the Bank of England(BoE) Financial Policy Committee(FPC) published the half-yearly financial stability report for UK banking overnight in which it urged UK banks and the Financial Services Authority ( similar to APRA ) to adjust their risk modelling to take a more ‘realistic’ view of current and future requirements.
The report states that:
While the immediate risks have reduced, there remains a possibility of disorderly outcomes, which if they occurred would have major implications for UK financial stability
In the report the FPC provided modelling of 4 banks, Barclays, HSBC, LBG and RBS and found that:
…. relative to a 4.5% common equity target, these alternative scenarios suggest that capital ratios for the largest banks in the United Kingdom could be overstated by the equivalent in capital terms of between £5 billion and £35 billion.
Interestingly, however, the FPC has also stated that required increases in capital need to be implemented in such a way as not to reduce lending to the private sector, which could be easier said than done. Evidence from the Eurozone suggests increased capital requirements have played their part in reducing overall lending because many banks have chosen to shrink their balance sheets rather than dilute existing equity holders in order to adjust the capital ratios. That is, they have sold assets rather than increase capital. This is certainly something that has had a disproportionate effect on Eastern Europe and something that will certainly be happening in Spain as their banking restructure works through the system.
There was a 1 hour press conference which is well worth watching as it provides a good explanation of exactly what the FPC is attempting to achieve and there is an interesting presser afterwards with some Q&A from the financial media. There is also some discussion of what Mark Carney’s influence maybe on the policy of the BoE when he takes up the role of Governor next year.
Although I have great interest in this topic what struck me most about the press conference was how “matter of fact” the FPC was about the problem. In comparison to my perception of Australia’s regulators of financial stability I found this approach very refreshing. The FPC appears to be tackling the issues head on by defining the problem, suggesting approaches to fix it and then working with the banks to get it done. Obviously you could easily temper this with accusations of poor oversight in the lead up to the GFC, as you could in most jurisdiction across the globe, but IMHO this is still a refreshing approach.
Full report below.