6 And, such an approach would require binding agreements amongst home and host resolution authorities. Vague assurances would not do the trick, as domestic authorities could change their minds when it really mattered. Host and home authorities would need “skin in the game” to underpin co-operation. And co-operation in distressed circumstances could helpfully flow back to how supervisors work together in peacetime. An obstacle to such an approach might be that in some countries, legislation mandates preferential treatment of creditors and depositors of local entities of cross-border banks. But that might be weighed by legislatures against the current reality that when the fiscal authority finds itself injecting equity to save a bank and preserve stability, it protects worldwide creditors not just its home creditors. To be clear, I am not advocating any particular approach here. I just want the authorities to articulate the issues clearly, so that our leaders can make a choice and think through the consequences of that choice. I’m not sure that it has really been put to them up to now. And, of course, whatever is done, within Europe we would need to find an EU version that sat between national and global regimes. Summary My purpose today is not to advocate solutions. It is to identify the big issues and to float some possible avenues for discussion in the EU and internationally. The big question is clear enough. Can we resolve distressed LCFIs in an orderly way without injecting public money?
Given this it may seem paradoxical for the Basel Committee to recommend a leverage ratio that does not vary with risk. However, we should remember – and this is important – that the traditional capital requirement has not prevented banks from borrowing too heavily, and this was one of the central problems during the financial crisis. As long as the economy ran smoothly the banks could use their debt-burdened balance sheets as levers and make large profits. However, as soon as the downturn began and the banks began to make loan losses they had hardly any capital that could be used to bear the losses. Instead, governments and taxpayers had to provide funds to rescue the indebted banks. Of course we do not want to experience such a sequence of events again. It is therefore positive that we are introducing a complementary capital requirement that ensures that the banks do not overburden themselves with debt. The idea behind the leverage ratio is to limit the growth of credit when the economy is going well. It therefore acts as a complement to the counter-cyclical capital buffer and helps to prevent an extreme expansion of the balance sheets. Another reason for introducing a leverage ratio is that most large banks use internal models to estimate the risks associated with their lending. If banks estimate these risks incorrectly, for example by underestimating them, they may not hold enough capital.