The global financial architecture has undergone significant changes ever since the financial crisis of 2008
21st January 2014
The UK banks are under pressure by the new regulator, Bank of England’s Prudential Regulation Authority (PRA), to bolster their capital safety nets so that taxpayers’ money is not called upon for bailout in case of another crisis. While the banking industry complains that new capital norms by the Bank of England could squeeze a bank’s balance sheet and making less capital available for business growth, the regulator argues that it will help tackle the problem of “Too Big To Fail”.
Back in June last year, PRA had asked the UK banks to find an additional £13.4bn of capital over and above the measures planned to shore-up the balance sheet of banks. The larger banks and banking society in the UK including Barclays Plc, HSBC Holdings Plc and Royal Bank of Scotland Group Plc will have to meet the capital requirement norms of the Basel Committee on Banking Supervision by Jan 1, 2014. The new norms also requires bank to meet a minimum leverage ratio, which requires lenders to set aside equity equivalent to three per cent of their assets.
The PRA published its latest rules and supervisory statements in December 2013 which complement the European Union (EU) legislative package known as “CRD IV” covering prudential rules for banks, building societies and investment firms, most of which are applicable from 1 January 2014. CRD IV is made up of the Capital Requirements Regulation (CRR), which is directly applicable on firms across the EU, and the Capital Requirements Directive (CRD), which must be implemented through national law. CRD IV is intended to implement the Basel III agreement in the EU. This includes enhanced requirements for quality and quantity of capital, a basis for new liquidity and leverage requirements, new rules for counterparty risk, and new macro prudential standards including a countercyclical capital buffer and capital buffers for systemically important institutions.
The Bank for International Settlements (BIS), based in Basel in Switzerland, is the body charged with establishing a framework for setting a minimum level of capital each bank should have to hold. Basel III — a new globally agreed regulatory standard for capital adequacy for banks — seeks to address three issues. First, banks will be required to fund their assets with more high-quality common equity capital. Second, capital will be required for a broader set of risks, including the risk of losses arising from deterioration in the credit quality of banks’ counterparties in over-the-counter (OTC) derivative transactions. Third, Basel III introduces new capital buffers over the minimum capital requirements.
The global financial architecture has undergone significant changes ever since the financial crisis of 2008. Policymakers and regulators have adopted macro prudential policies to contain systemic risk as the crisis brought to the forefront the inability of banks to fund their assets without sufficient high-quality equity capital buffer.
Bank balance sheets size in the UK is more than four times the country’s GDP, higher than most European nations as well their stronger counterpart, the US, where banks’ assets hardly match GDP. Although capitalization levels at the UK banks are adequate as per the international norms, the regulator seeks to provide more buffer against shocks in the future. Last year rating agency, Moody’s Investors Service had raised its outlook for the UK banking system from negative to stable on the back of improving profitability and lower impairments after lenders stepped up its efforts to clean up balance sheets and raise capital ratios. The rating agency company had said, “In the long term, Moody’s expects U.K. systemic risk will be reduced by higher capital requirements, including significant loss-absorbing and counter-cyclical capital buffers”. It further reiterated, “The stable outlook for the system is compatible with the stable outlook on the standalone credit assessment of most U.K. banks.”