Last year, the Bank of England subjected UK banks to a sharp slowdown in China, a fall in oil prices and intense market volatility, coupled with stressed estimates of redress costs for past misconduct. Across the system, banks in the test incurred losses of £ That’s over twice the losses of the system in the financial crisis. Back then, losses on that scale would have wiped out almost two thirds of the capital of the entire British banking system. With so much more capital today, the stress test showed those losses could be absorbed, even while the system continued to grow credit to the real economy. Far from sideswiping the real economy under stress, the test showed the banking system could continue to support it. 1 And yet, there is still, eight long years after the crisis, a lively debate in newspapers, blogs and academia, about whether the capital strength of the banking system should be built up further. 1  Available at http://www.bankofengland.co.uk/financialstability/Documents/fpc/results011215.pdf. BIS central bankers’ speeches  1  About whether authorities should abandon the conclusions of Basel III and of the UK’s post-crisis Independent Commission on Banking and compel banks to go further. A debate like that is all to the good; these are important questions for society. But it has to be balanced against the merits of clarity. Clarity you need to run your businesses effectively. Clarity investors need to allocate and price capital efficiently. Clarity the public, and Parliaments, need to hold policymakers and banks to account.
The most interesting thing I heard a senior policymaker say about the financial crisis, not a Bank of England policymaker, was that we spent far too long thinking about whether there was a housing bubble and not enough time thinking about what if there is a housing bubble. The consequences for banks will be informed by our annual stress test. With the stress scenario varying systematically with our assessment of the risks, the test will guide us as to how – given banks’ exposures – our judgement about the risks should be reflected in capital buffers. In addition, we’ll have a bias to acting early and gradually – to raising countercyclical capital buffers before the threat level is seen to be heightened. The Bank of England expects to be adding around 1% to the capital buffer on UK exposures of all banks, even before the overall threat of future losses looks high. That bias reflects the time lags in implementation and in the cost of time-varying buffers lagging behind the threats. As well, there is clear evidence that sudden, sharp increases in capital requirements can have a material effect on credit supply and economic activity. Acting earlier allows us to take smaller steps. With this approach, the UK’s systemic banks will, except in post-crisis repair, be required to run with capital buffers a little above our baseline standard. Leverage requirements will also be scaled up, with banks typically being required to fund no less than 4% of total assets with tier 1 capital.