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UK financial regulation relaxed to promote growth

by William Arnold | Oct 17, 2012

Britain's financial regulator (the FSA) has relaxed capital and liquidity rules for banks in an effort to stimulate lending and boost the recession-hit economy.  This represents a significant policy shift and coincides with the recent (14 June) change in the Financial Policy Committee’s (FPC) mandate from a single focus on financial stability to a dual focus on stability and growth.  This also puts the UK at the forefront of the use of bank regulation to moderate economic cycles – a new phenomenon driven by Basel regulation.

Changes include:

  1. Capital - Regulators have stepped-back from tough overall capital rules they imposed after the Basel III reform package was adopted. No longer will UK banks be required to achieve and maintain a core capital ratio equal to 10% of risk weighted assets (RWA) by the end of next year. Instead, banks will be required to hold an absolute level of equity (not disclosed), rather than equity being expressed as a proportion of RWA. This is a significant change and different from all other major economies
  2. Funding for lending - The regulator will not require banks to hold extra capital against new lending that qualifies for the "funding for lending" scheme (intended to encourage banks to lend more to the corporate sector). However the market and rating agencies will likely still look for capital to be held against incremental risk
  3. Liquidity - The FSA has also relaxed liquidity rules to include a broader variety of assets in the buffers that banks must hold in case of a run by depositors or other market crisis. Up to now, only sovereigns and cash were acceptable, but now banks can hold up to 10% of the required buffer with anything that qualifies as Bank of England collateral

Andrew Bailey, the head of the FSA’s prudential business has described the goal of this overall package of measures as being “to avoid rapid deleveraging that would harm activity in the economy”. Taken together, these changes are aimed at heading off a double-dip recession and making sure that regulation is not choking off the flow of capital to the real economy.

The FSA’s move highlights how the UK is at the forefront of a new “macroprudential” approach to oversight in which regulators consider not just whether individual banks are sound but also broader economic and stability concerns.  Other countries may not be far behind. Under the Basel III package, member nations are specifically encouraged to consider imposing so-called “countercyclical capital buffers” to smooth economic cycles.