posts | research

Systemic risks and banks´capital: a well-meaning illusion?

Are the capital requirements high enough and a sufficient buffer in a next crisis? No one can seriously answer the question how much and which capital is exactly necessary. But looking back at the 2008 financial crisis one can assume that much more than present levels of capital could be eaten up. The Bank of England started in January 2016 a consultation on the framework for risk buffers, entailing an intense debate.

26 February 2016
Martin Aehling

Can European banks withstand crisis? Believing financial institutions, capital and capital surcharges are set well enough and already present a heavy burden on banks´ business. Regulatory authorities as well argue that capital requirements are by now well-adjusted, although there have been very different views on this essential point since a long time. Particularly for systemic banks the arguments differ considerably. The Bank of England started end of January a consultation on a framework for systemic risk buffers, flaring up the debate on adequate capital requirements.

Sir John Vickers, who chaired the U.K. Government’s commission on the future of banking, asked 15 February 2016 on “How much equity capital should UK Banks have?” while reviewing the Bank of England’s framework for the systemic risk buffer. In his view there are reasons to query the justification for the Bank of England’s apparent policy softening on bank equity requirements, as the downside risks are much larger than the costs of having an equity/debt mix in bank funding that is a bit higher than optimal. Vickers underpins his remarks with a recent watching: “Meanwhile the markets have something to say.  In the early weeks of 2016 bank stocks and related instruments have dropped sharply.  This is a timely market reminder that the resilience of the banking system cannot be taken for granted.  Policy in this area really matters, and calls for vigorous economic debate”, he says.

And in an opinion in the Financial Times from 14 February 2016 Vickers writes that volatility in bank stocks underlines the importance of strong capital buffers, the Bank of England shall think again on systemic risks accordingly. Titleing “Vickers lashes out at BoE bank buffers” the FT resumed his arguments.

The Independent follows up with an article informing that Sir John Vickers warns on inadequate bank capital. His arguments were taken up again by having a broader look on regulation when headlining “Banking reform has been made more confusing than it needs to be”. Deputy business editor Ben Chu explains that “Part of the debate seems to hinge on whether one should count a type of special bank debt that automatically converts to equity in a crisis as a part of a bank’s official equity or not. There’s a strong case for not doing this, since these financial instruments are clearly untested.” He made one important point when saying that this debate is perfectly impenetrable to the non-expert: “If people grasped what was at stake and how little had been done on equity, the clamour for action would be deafening. But the ordinary citizen, whose money is on the line, is blinded by jargon”, he comments.