For this second category, it is often difficult or expensive to monitor the risks on the bank’s asset side. One important aspect of bank regulation is the requirement for the amount of capital the banks should maintain. As capital adequacy requirements play a central part in the discussion of financial stability, I would like to examine them in a little more depth. There is a difference between the private and social benefits and costs of financial regulation Demands for bank regulation are not infrequently met with resistance from interested parties who claim that regulation is too expensive. Not least, this resistance is aimed at higher requirements for banks’ capital adequacy, as the interested parties claim that capital is more expensive than loans. But in this context, it is important to make a distinction between private costs and social costs. Higher capital adequacy requirements entail private costs for the banks. But we public sector participants should primarily be discussing the social consequences. 2  BIS central bankers’ speeches  One cornerstone of modern financial research is the basic theory that was established by Modigliani and Miller over 50 years ago.1 This says that the value of a company does not depend on how that company is funded – under certain assumptions. In principle, the model shows that the form of funding is only significant if there is a difference between the debts of companies and those of private individuals.
So how will the FLS help? Let’s be clear on one thing. It is up to the banks whom they lend to. If a firm goes under, or simply can’t repay its loan, that bank loses money: under the FLS the credit risk stays with the banks. And it is not our intention that banks put themselves at risk by making imprudent loans. Although there are many good quality businesses seeking extra credit, not every one is as good a credit risk as they might make out to their local journalist or MP, so we need to be wary of judgement by anecdote. But the FLS will put the pressure on banks to lend where they profitably can. That may “turn the conversation around” as banks do more to seek out lending opportunities rather than businesses or home buyers struggling to find accommodating banks. If demand for credit turns out to be weak then that will add to the competitive pressures on the supply of credit. In summary, I am confident that the FLS will help the supply of credit. Before its introduction, it was more likely than not that the stock of credit would contract further over the next 18 months. Perhaps it still may. But any return to positive credit growth would be a better outcome than we could have previously hoped for. But I want to underline one thing about the expected outcome: I expect banks’ usage of the scheme to exceed their lending growth.