U.K. Bank Capital Rules Overhauled as BOE Moves From Crisis

  • Resolution, regulation allow more efficent structures
  • U.K. system `within sight' of appropriate capital level

The Bank of England set a capital target for the U.K. banking system well below global guidance, taking advantage of regulatory advances and greater financial stability to streamline rules intended to make lenders more resilient.

The “appropriate” level of Tier 1 equity, a regulatory measure of financial strength, for the banking system in aggregate is 11 percent of risk-weighted assets, the BOE said on Dec. 1 in a new capital framework for U.K. banks. The target for common equity Tier 1, the highest quality capital, is 9.5 percent. That’s well below the 18 percent recommended by the Basel Committee on Banking Supervision, according to the BOE.

This lower level is made possible by new rules for handling failing banks, tougher capital requirements and supervision put in place since the financial crisis and a nimble new tool, the countercyclical capital buffer, that the Bank of England can use to force lenders to set aside capital to support lending in a downturn, according to the central bank.

“We’ve looked at the overall level of capital we think the system needs; the system is within sight of it,” Governor Mark Carney told reporters after the BOE released the results of its latest stress test, which was passed by the seven largest U.K. banks. Regulatory strengthening since the crisis means that now the central bank “can run a more efficient capital structure” without putting stability at risk, he said.

‘More Capital’

In addition to the structural Tier 1 target of 11 percent, “time-varying additional requirements” may be imposed, averaging 2.5 percent, for a grand total of 13.5 percent. “As currently measured, the U.K. banking system has Tier 1 equity of 13 percent of risk-weighted assets,” the bank said. “So it only has a little more capital to build, in aggregate, by 2019” when existing EU capital rules are fully in force.

Once new bank-resolution rules known as total loss-absorbing capacity, recently adopted by the Group of 20 nations, are 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,” Carney said.

The BOE plans to use the countercyclical buffer to help simplify its capital requirements and make them more transparent.

‘Appropriate Setting’

Active use of the buffer means “we don’t carry extra capital in all states of the world, but we increase it when the system requires it,” Carney said.

As a first step in setting the buffer, supervisors will identify risks covered by existing requirements that can be captured by the countercyclical buffer, Carney said. The BOE’s Prudential Regulation Authority will then carry out a one-time review of individual firms’ buffers in the first quarter of 2016 and it will raise the countercyclical buffer from zero without necessarily changing the overall capital charges for banks.

After that, the BOE’s Financial Policy Committee will “carefully review the appropriate setting of the buffer rate in March,” Carney said. The FPC left the rate at zero percent for domestic exposures on Tuesday. It intends gradually to increase the buffer to 1 percent, equivalent to about 10 billion pounds ($15.1 billion), as the U.K. economy recovers from the crisis and risks to stability re-emerge.

“They’re moving the deckchairs around, putting the same capital into different categories,” said Bob Penn, a regulatory partner at Allen & Overy LLP in London. “In practice, it achieves a higher degree of transparency and a greater degree of accountability. The BOE will be answerable for it when they call the cycle wrongly, as they inevitably may, sooner or later.”

Before it's here, it's on the Bloomberg Terminal.