I want to briefly mention two possible factors that may be affecting investors’ perceptions of risks and hence of the returns necessary to compensate for them. First, there may be a collective action problem on the part of asset managers. Around half to two-thirds of the shares of the largest UK banks are owned by institutional  BIS central bankers’ speeches  7  investors and managed in-house or by asset managers. 14 These tend to operate to common benchmarks and are subject to rigorous peer comparison. Asset managers, particularly those managing assets on behalf of institutional investors that have fixed liabilities, are currently under great pressure to find returns in a low return environment. Before the crisis, banks made high double-digit returns on equity boosted by very high leverage. There may well be a reluctance among managers of institutional money and investment funds to be the first to drop required returns. This could account for some of the stickiness that we have seen in banks’ return on equity targets. The behaviour of institutional investors may also explain the so-called “low risk” anomaly. In theory, lower risk ought to be matched by lower returns. But some research suggests that this may not be a simple relationship. The “low risk anomaly”, under which lower risk stocks generate no lower – and in some cases higher – returns than higher risk stocks has been identified for banks.
Most importantly, we will not accept empty shell companies. All entities in the euro area must have adequate local risk management, sufficient local staff and operational independence. All that should be self-evident. Banks which seek to permanently book all exposures back-to-back with another entity in London should change their plans. And so should banks that plan to book all exposures with a euro area entity while having their risk management somewhere else. We are aware that it is a burden for UK banks to apply for a new licence in the EU. With a view to internal models, we would aim to be accommodating regarding the timing. There will be a transitional period in which new euro area entities might use internal models that have not yet been approved by the ECB. But of course, there are conditions attached. First, the relevant models must have been approved by the UK’s Prudential Regulation Authority. We would also reflect on any comments on the quality of the models from our UK colleagues. Second, the banks must have applied for internal model approval in the euro area. The transitional period will cease as soon as we have approved or rejected the bank’s model application. Ladies and gentlemen, sound banks are at the heart of a strong economy. Banks therefore should note Walter Bagehot’s words and remain cautious. It is our job as supervisors to help them do so and steer clear of risky adventures. Thank you for your attention. 2/2  BIS central bankers' speeches