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UK's proposed macro-prudential tools look to support banks

by William Arnold | Oct 03, 2012

On 18 September the UK government published The Financial Services Bill: the Financial Policy Committee’s macro-prudential tools.  This paper proposes powers the Financial Policy Committee (FPC) would have to address systemic risks in the UK financial system.  The tools are broadly credit positive for UK banks by addressing asset bubbles and the emergence of excessive leverage.

The document proposes the following:

  • To make the FPC responsible for setting the UK’s counter-cyclical capital buffer (part of Basel III requirements)
  • To give the FPC the power to impose additional capital requirements on banks
  • To give the FPC the ability to set a minimum leverage ratio.

Such powers, previously not held by the UK regulators, enable the imposition of additional standards above the internationally agreed upon minimum (for example Basel III regulation).  They will enable the regulator to manage systemic risks as they emerge, in a more dynamic way by stopping the build up of excessive leverage and the ability cool overheated sectors as they emerge.

There are however, possible issues with the proposals:

  • If the FPC was to lower capital requirements in order to stimulate growth during a recession, this may be at odds with broader regulatory aims of building capital at individual banks during this time to avoid solvency risks. Therefore investors in specific banks may find their position weaken (given the run down in capital in order to stimulation of the broader economy). Capitalisation is also a key driver of market confidence, so for a bank to run down its position during weak economic conditions may be difficult and impact its ability to access investors/funding
  • The FPC’s financial stability objective may also be at odds with the government’s interest in promoting growth.  During good, strong economic times the decision to deploy these tools and the timing will be fraught with difficultly.  It will be a tough call to choose when to limit growth in some sectors - especially given this will probably be at odds with governmental and political will.