Bank of England and Vickers clash on capital rules

Both central bank and ring-fencing committee chair claim to have recommended higher capital requirements than the other – but a look at the proposals suggests the differences are slim

John Vickers

The Bank of England (BoE) has dismissed concerns its capital requirements are too low, responding to criticisms raised by John Vickers, who chaired an influential banking reform committee.

In articles published in the Financial Times and Vox on February 15, Vickers warned that the BoE's framework for capital requirements, particularly its systemic risk buffer, could fall short of what his committee, the Independent Commission on Banking (ICB), proposes.

Nevertheless, in a statement, the BoE contends its proposals are for a "higher level of capital and overall resilience in the banking system" than the ICB sets out in its final report.

At first glance it appears the BoE and Vickers cannot both be right. But examining the proposals more closely implies the disagreement is more over detail than substance.

Vickers argues the BoE's recent proposals for the systemic risk buffer will yield a lower level of capital for ring-fenced banks than the ICB recommended. "The Bank of England's policy is significantly softer," he says.

The ICB wants a flat 3% requirement to be added to all ring-fenced banks with assets above around £160 billion, while the BoE is choosing to impose a sliding scale of surcharges up to a maximum of 3% on banks with more than £175 billion in assets. Currently no bank appears to meet the 3% threshold (£755 billion assets).

In the case of banks subject to both the ring-fencing requirement and the global systemically important bank (G-Sib) surcharge applied by the Financial Stability Board, the larger of the two requirements will apply: both the ICB and BoE agree on this point.

Overall, the BoE estimates its surcharge will add around 0.5% to bank capital requirements, because most ring-fenced banks are already part of banking groups subject to the G-Sib charge.

Vickers cites research by Stanford economics professor Anat Admati, which calls the BoE's cost-benefit analysis of higher capital requirements "fundamentally flawed" for failing to fully account for the costs of undercapitalised banks.

Admati favours significantly higher capital requirements (potentially as high as 25%), but Vickers shies away from such a strong argument. "There are reasons to query the justification for the Bank of England's apparent policy softening," he says in the conclusion to his Vox piece. "Perhaps the Bank is perfectly correct, but its policy on a matter of this importance should be questioned."

Vickers correctly points out the BoE's systemic risk buffer is slightly smaller than the ICB would have liked. But taken as a whole, the capital frameworks proposed by the two groups remain similar.

In its final report, the ICB says large ring-fenced banks should maintain common equity of at least 10% of risk-weighted assets (RWAs), with a leverage ratio of around 4%.

Unlike the ICB proposal, the BoE capital framework allows up to 1.5% contingent capital. In terms of common equity, the minimum is 7% plus the systemic risk/G-Sib buffer of 0–3%, plus a discretionary "PRA buffer" and the countercyclical capital buffer.

The BoE says this will likely yield total capital of around 13.5% (12% common equity) in normal times when the framework is complete. The BoE's leverage ratio is set using a 0.35 conversion factor – so a bank with a 13.5% capital requirement would face a 4.7% leverage ratio.

In its statement, the BoE says banks are "within touching distance" of meeting their final capital requirements, which will only bind from 2019. As of Q3 2015, the UK's largest banks had a total capital ratio of 12.2% of RWAs on average and a leverage ratio of 4.7%. None had less than 11% capital or 4% leverage.

The ICB report also says banks should hold additional loss-absorbency, for example in the form of bail-in-able debt, to bring total loss absorbency up to 17% of RWAs, with an additional 3% buffer to be imposed if regulators have concerns on resolvability.

The BoE's proposals for total loss absorbency are contained within its framework for "minimum own funds and eligible liabilities" (MREL). This says large banks must hold bail-in-able debt worth the same value as the bank's basic capital requirement plus individually tailored requirements. For the average bank at present, this yields total MREL of 17% of RWAs, and could be pushed higher at the Prudential Regulation Authority's discretion.

The ICB's final report says it ideally favours an even higher capital requirement, but stops short for fear that this would not be replicated in other parts of the globe. There is scope for debate over whether the BoE/ICB capital requirements go far enough – but as it stands, the two proposals look alike.

The BoE's MREL and systemic risk buffer proposals remain open for consultation until March 11 and April 22 respectively.

This article originally appeared on Risk.net's sister website CentralBanking.com.