Today’s Review details plans that will demand much larger capital reserves set aside by banks in an attempt to protect their balance sheets against any future downturns and to stop the over-leveraging of balance sheets.
The regulator will want to see more and higher quality bank capital, with at least three times as much capital required to support “risky trading activity” in the wholesale markets. It hopes by demanding so much of banks dealing in these markets, it will simplify and derisk the securitised credit model.
It will demand that banks’ Tier 1 and Core Tier 1 ratios are much higher than Basel II deems necessary. The FSA admits that this will mean lower return on equity but it will lower risk in the banking sector.
It will also demand a counter-cyclical capital buffers, which will require banks to build up capital in good economic times so that they can be drawn on in downturns, and reflected in published account estimates of future potential losses. By doing this, the FSA hopes to reduce the amplitude of economic cycles. It says it may enforce this by either a “discretionary or formulaic” method.
There will also be a fundamental review of remuneration in the banking sector; the FSA wants management in the banks to be “less influenced by irrational behaviour”.
One problem the FSA will also combat is that of “liquidity through marketability” where banks deem how liquid an asset is by an assumption of what it is worth on the market. It says it will embark on a “major intensification” of liquidity regulation to make sure liquidity strain is limited in the future.