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.
This is a reflection of the unusual and difficult economic conjuncture that we have been going through, combined with the challenge of determining the scale and nature of, for instance, loan forbearance. This is particularly evident in areas like commercial property lending where there is a hump of loan refinancing to come and a quite sharp tiering of performance among assets. Second, the euro area, and the possible impact of disorderly break-up, should that happen (and in saying this, I offer no view on whether it will happen), could have a sizeable impact on many banks. But here the FPC faces another very difficult judgement, namely what scale of so-called tail risk – the losses from low probability but high impact events – do we wish to see covered in the capital held now by banks? In other words, how much insurance should come from capital providers? The broad answer is a lot, but that does not tell us how much,  BIS central bankers’ speeches  3  and in the limit there are utterly catastrophic risks for which it is not sensible to hold capital as the answer. Third, when we look at the low market value of some banks relative to their book value, how much of this should we attribute to lending margins being considerably lower than they were expected to be? Net interest margins are squeezed in the current environment.