The unexpected appointment of Mark Carney as Bank of England (BoE) governor, effective in July, has set off fervent speculation over how his Canadian experience and role as Financial Stability Board (FSB) chairman at Basel will shape his UK banking responsibilities. As Euromoney has reported, in an interview published in October, Carney indicated he was in favour of the universal banking model, buttressed by strong minimum capital-adequacy requirements, increased risk-weighting and value-at-risk modelling of trading books, as well as sound supervision. The comments suggest Carney is comfortable with the UK governments drive to enforce greater ring-fencing between the investment-banking and retail-banking divisions of banks rather than pushing for full separation of both operations. Accordingly, Carney is likely to strike a constructive tone on the merits of the UKs Vickers report and the EUs Liikanen review, which seek to ensure monoline banking arms of a holding firm can be unwound in the event of a crisis, without imperiling depositors. Both reports recommend beefier loan-to-value limits for real-estate lending and better comparability of internal risk models between banks. This UK and EU consensus on the structure of domestic banking systems should provide a rare source of comfort for Carney, who faces a daunting battle elsewhere: namely, the challenge of preserving the UKs interests amid the EU banking union-drive, without being accustomed to the finer points of EU politics and legislative technicalities.
|Mark Carney, Bank of Canada governor|
Lobby for leverageThe UK governments move to opt for a 3% minimum ratio implies that the leverage ratio, as it stands today, will be a secondary, rather than primary, capital constraint on the UK banks, said analysts at Citi in a mid-September research note, adding: We would not be surprised if this mindset eventually changes. Indeed. On the issue of the leverage ratio, Carney is likely to form an alliance with Andy Haldane, responsible for financial stability at the BoE. As Euromoney has reported, Haldanes views on removing risk-weighing from the calculation of banks capital have earned a rebuke from Carney but they both agree on the efficacy of strong leverage ratios. Haldane, in recent speeches, has favoured strong nominal capital measures, with a leverage ratio of 7% and above, as a backstop against bank failures. As this chart from Citi lays bare, using Haldanes data, the pre-crisis leverage ratio of failing banks was statistically significantly lower than that of surviving banks at a 1% significance level, say the Citi analysts. By contrast, the same cannot be said of risk-based capital ratios, which were not statistically significantly different between failing and surviving global banks.
(Nevertheless, enforcing a leverage ratio, without risk-weighting, is a flawed approach, since it gives banks an incentive to load up on risky, high-returning assets to reduce their loss-absorbing capital requirements, reckons Carney.) The current Basel and UK minimum is for a 3% ratio but, in practice, most UK banks run higher leverage ratios, in response to investors demand for higher loss-absorbing capital than the regulatory minimum. However, the battle is now on. The Basel Committee is looking to impose a binding requirement by 2018, though its unclear whether even this lengthy time-line will be met, given the US decision to postpone the January 2013 initial Basel III start-date. Most controversially, the Basel leverage-ratio proposal includes on-balance-sheet and off-balance-sheet exposures, a game-changer for US and UK banks capital requirements, in particular, given the size of their derivatives items and international trade finance lines. As Euromoney has reported, banks are lobbying against any punitive inclusion of off-balance-sheet contingent liabilities essential for trade financing, such as guarantees for performance bonds in project financing and standby letters of credit. The Basel proposal would disproportionately hit trade-orientated UK banks, such as HSBC and Standard Chartered, says Hank Calenti, head of UK bank credit research at Société Générale. Analysts at Citi speculate that a leverage ratio of around 5% to 6%, based on adjusted assets, netted for derivates and excluding liquidity reserves, would reduce systemic risk without imperiling banks capital positions. However, they concede such a move would prove controversial, and most likely to be enacted if the EU followed suit. Nevertheless, a compromise could be found, said the Citi analysts. A potential quid pro quo could then be that the Basel III core tier 1 ratio target is reduced to c8% to 9%. This would be more consistent with global standards than the 10% currently being pursued by the UK authorities, and would also make sure that the leverage ratio becomes a primary policy tool alongside risk-weighted metrics, rather than a redundant measure of capital strength. The jury is out on how much UK political capital Carney will have, or seek to deploy, in any fight for a higher leverage ratio, particularly given the governments rejection of the ICB leverage recommendation.
The former Goldman banker has juggled his role as a global bank-reform aficionado with his Canadian interests namely stating the Volcker rule is impractical and could put non-US sovereign bond markets at a competitive disadvantage. However, in the battle to shape the leverage ratio, Carneys UK and FSB roles will prove a tough balancing act.