Carney’s Bank-Failure Faith Leaves U.K. Vulnerable, Vickers Says

  • EU authorities are setting banks’ loss-absorbing requirements
  • Vickers isn’t alone in his skepticism about bail-in measures

Bank of England Governor Mark Carney’s belief in new bank-failure rules may leave the financial system short of equity and vulnerable to shocks in a crisis, according to John Vickers, the chief architect of reforms that are remaking the U.K. banking industry.

As authorities across the European Union, including the BOE, set requirements for loss-absorbing liabilities that could be used to stabilize and recapitalize a foundering lender, Vickers said they ought to be concentrating more on preventing failures in the first place by demanding banks have more equity capital.

John Vickers
John Vickers
Photographer: Joshua Roberts/Bloomberg

“Bail-in debt increases very substantially the chances that if these institutions become gone concerns the taxpayer will be much less exposed than last time around,” Vickers said in an interview. “But nothing is certain, particularly in a systemic crisis. Imagine the Friday afternoon when the banks are looking over the precipice; it’s a huge leap of faith to think it all works smoothly.”

Vickers isn’t alone in his skepticism about EU and global rules intended to prevent future bailouts by imposing losses on creditors when a bank gets into trouble. Andrew Tyrie, head of the U.K. Parliament’s Treasury Committee, and Bank of Italy Governor Ignazio Visco are among the policy makers who have registered concerns about a regulatory approach based on the largely untested bail-in tool.

‘More Confidence’

The BOE unveiled its new capital framework in December, setting an aggregate Tier 1 requirement -- the core regulatory measure of financial strength -- for the U.K. banking system of 11 percent of risk-weighted assets. That’s well below the 18 percent recommended by the Basel Committee on Banking Supervision, according to the BOE.

In explaining the lower number, Carney cited new bank-resolution rules known as total loss-absorbing capacity adopted last year by the Group of 20 nations. When TLAC is fully implemented, the BOE will have “much more confidence” that it will be able to wind down even the country’s largest banks, Carney said. This certainty translates to about “5 percentage points of the reduction of that overall level of capital,” he said.

The BOE acknowledges that setting appropriate capital requirements is an “uncertain” business. “Most notably, if bank resolution were to prove unable to deliver the benefits projected in the assessment, the appropriate equity requirement for the system as a whole would be materially higher, at least 16 percent,” according to the capital framework.

‘Fire Prevention’

Vickers seized on this point in a letter published on Feb. 17 in the Financial Times, likening loss-absorption rules to fire extinguishers that can reduce the damage caused by a blaze. “But that is no good reason to economize on fire prevention,” he wrote.

Carney has rebuffed the criticism from Vickers, saying in February that the BOE has exceeded the Vickers commission’s recommendations on equity capital and total loss-absorbing capacity.

Vickers’s criticism carries weight. He chaired the Independent Committee on Banking, whose report in 2011 set out the future shape of the U.K. domestic banking industry with its recommendation that the major banks shield their consumer units behind a so-called ring-fence. He has served on the BOE’s Monetary Policy Committee, and is now warden of All Souls College, part of Oxford University.

‘Extremely Difficult’

His concerns about bail-in debt were taken up by the Treasury Committee’s Tyrie in a June 6 letter to Andrew Bailey, the BOE deputy governor for prudential regulation. Tyrie questioned the assumption by regulators that forcing losses on creditors of a failing bank would improve market discipline by turning bondholders into owners after restructuring.

Recent events in Italy and Portugal “show that the implementation of bail-in is extremely difficult in practice,” Tyrie wrote.

In April, the Bank of Italy’s Visco was more blunt. “It doesn’t look good to say that we have bail-in in place when everyone knows that it can’t be used because of these systemic and contagion risks,” he said.

Vickers also took aim at the BOE’s systemic risk buffer, a layer of capital designed to ensure domestic lenders can keep credit flowing under stress. This should be set at 3 percent of risk-weighted assets, which banks could “easily achieve by 2019” and would bolster financial stability.

Countercyclical Buffer

The BOE opted for a tiered system, starting at zero percent for lenders with total assets of less than 175 billion pounds ($248 billion) and rising to 3 percent for firms with total assets of at least 755 billion pounds.

If the BOE has set the systemic risk buffer too low, its plan to use a so-called countercyclical buffer to counteract banks’ tendency to boost lending in boom times, fueling the expansion, and slash it in the bust, could come too late to be effective, Vickers said.

“We’re talking about very, very early days and I simply do not believe it can work as well as the Bank of England believes,” he said of the capital framework. “I hope it will, but I just don’t believe it will, with the best will in the world.”

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