So, as you can see, designing a simpler framework is not a simple task! Our discussion paper elaborates on all these choices, and I hope to have whetted your appetite to get involved in the discussion by responding to our paper. Leverage Ratio and MREL reviews Next, I want to move on to something a bit more relevant in the shorter-term to some of the larger BSA members with us today – the links between the leverage ratio and MREL reviews. I am conscious that at the moment this may be relevant to only a handful of you, so in case you are still listening to my speech I will aim to be brief. The Prudential Regulation Committee and the Financial Policy Committee are conducting a review of the UK leverage ratio framework in light of the now-finalised international standards.3 At the same time, the Bank, as Resolution Authority, is conducting a review of its MREL framework and how it applies to mid-tier firms.4 As many of you know, this alignment of timings is not coincidental as the two are closely linked. How so? At first look, one link is through the calibration of MREL. For firms subject to bail-in resolution strategies, MREL is calibrated as twice the applicable minimum requirements set by the PRA. So if a firm is subject to a minimum leverage ratio requirement, this will typically be doubled-up in their MREL. But the two are linked in another way, which gives this doubling-up an additional significance.
In practice, the opposite happened (Charts 2 and 3). Capital and liquidity ratios have fallen secularly in the UK and US for over a century. Since the start of the 20th century, capital ratios have fallen by a factor of around five in the US and UK. Liquidity ratios have fallen by roughly the same amount in half that time. Taken together, these balance sheet trends indicate a pronounced rise in banking system risk and hence in potential demand for state insurance. They have also affected the returns required by bank shareholders. As banks moved up the risk spectrum, the return required by shareholders has predictably increased. Between 1920 and 1970, the return on UK banks’ equity averaged below 10% per annum, with low volatility of around 2% per year (Chart 4). This was roughly in line with risks and returns in the non-financial economy. The 1970s signalled a sea-change. Since then returns on UK banks’ equity have averaged over 20%. Immediately prior to the crisis, returns were close to 30%. The natural bedfellow to higher return is higher risk. And so it was, with the volatility of UK banks’ returns having trebled over the past forty years. 4  Indeed, contract incompleteness is one of the reasons banks exist in the first place (Rajan (1998)). 5  See, for example, King (2009). 2  BIS Review 139/2009  This regime shift upwards in the risk and return profile of UK banks can be explained by the fall in their capital ratios.