And third, as part of this, we are very focused on understanding business models, how firms make money, the risks they take. This, too, is a feature common to our supervision of banks and insurers. To give you an example, the high return on equity and low cost of equity business model is dead. It should never had been alive, because it could only exist through a misunderstanding of risks. Moreover, banks can alter their cost of equity through the choices they make on risk. Sometimes I hear the cost of equity explained as if it is exogenous, but it is not. Let me turn now to the current situation. I am not going to tell you the answer to whether the UK banks need extra capital, if so, how much of what type, and how rapidly should it be put in. The answer will of course differ for each bank. Let me though set out some of the considerations that shape the answers, and in doing so remember that we have to take into consideration the sizeable increase in capital in the system since 2008. And let me also emphasise that the FPC does need to reach a conclusion on these issues soon, and in doing so reduce one contribution to uncertainty over the future. The first consideration to note is that we face a situation where there is uncertainty around our judgements on the quality of a number of asset classes and their valuation.
I was dismayed to hear recently a commentator saying that, “supervisors will never be more than box-tickers”. Wrong. If you don’t agree, meet my colleagues. I was also interested to read recently a claim that today supervisors are unable to stand up to the banking lobby. Wrong. We accept that in a judgement-based approach to supervision, there will be disagreement. We don’t seek disagreement for the love of it, but it is part of what we do. In terms of how supervision is done, my preference is to start with a risk-based approach to assessing capital needs and then back that up with other risk-based approaches and a simple non-risk based approach, like a leverage ratio. The general approach is also the one that we are developing for insurers by designing early warning indicators to act as a check on the modelled risk-based approach. Why do I start with a risk-based approach? Because there is a logic to the approach of the supervisor mirroring how the firm manages risk for itself. I would be horrified if a firm said to us, “you know, we don’t bother to assess the risk we are taking”. Some history is relevant here. Modern risk-based capital requirements began with the Basel I Accord in the late 1980s. I was in Banking Supervision at the Bank of England then as we implemented Basel I. It had simple, crude, risk weights, but it was better than anything that had come before.