By making firms safer, it is possible that the required risk premia in bank capital and funding instruments will be lower, and hence the effect on the overall cost of funding is uncertain. In addition CRDIV also makes changes to rules on corporate governance, including remuneration, and introduces standardised EU regulatory reporting. These reporting requirements will specify the information firms must report to supervisors in areas such as own funds, large exposures and financial information. CRDIV will take until 2019 to be fully implemented. In addition to CRDIV, there are a number of other reviews and developments affecting the banking capital framework. The PRA has been undertaking a review of its approach and application of Pillar 2A requirements to ensure consistency of application across firms. That will be complete in 2016H1. The BCBS is also continuing its work including reviews of the capital held against the trading book, sovereign risk, and securitisation, and more generally reviewing the use of models and Pillar III disclosures. Leverage The capital requirements for a bank are generally calculated by first weighting together the assets of a firm, reflecting the underlying risks of each type of asset. Hence the key metric is the capital held relative to “risk weighted assets” or RWAs. Whilst the general approach of being risk sensitive is widely accepted, it does raise issues around consistency.
These changes should have no impact on the reform agenda and so I won’t pursue them further in this lecture. The PRA Board is independently responsible for delivering the PRA’s statutory objectives. It does this by making policies and rules, supervising authorised firms, giving directions, issuing guidance and carrying out other legislative functions. In practice the Board is the senior supervisory committee in the PRA, but delegates some of its functions to the PRA Chief Executive who in turn delegates to the management and staff. In 2014/15 the Board met physically 32 times and had one additional teleconference. That’s enough scene-setting. Let’s get on to the reforms themselves. Capital: banks Arguably the single most important objective of a prudential regulator is to make sure that firms have an appropriate level of capital. The objective is two-fold. First, there must be sufficient capital to absorb the losses that a firm might make, even under relatively pronounced stress. Second, after the stress, there should be sufficient capital left such that the firm can either (a) carry on its critical economic functions, with customers and market counterparties believing it remains safe and sound, enabling market access to funding and capital or (b) be safely wound up. It was evident during the financial crisis that the point at which a financial firm is no longer trusted by customers or counterparties can come before it runs out of capital completely or even approaches that level.