Vickers outside the ring fence: part 2 September 13, 2011 at 6:24 am

After yesterday’s part 1, here is part 2 of my brief survey of the Vickers Commission report. As before, it concentrates on the proposals which are not related to ring fencing.

First an encouraging section that shows that Vickers understands something of the role of capital:

For banks’ CCBs [capital conservation buffers] to provide efective pre-resolution loss-absorbing capacity which can be used without immediately raising concerns about a bank’s viability, it is important that the market does not regard them as simply extending the hard minimum equity requirement. The authorities should make it clear that they do not consider the CCB as doing so, and give due regard to this when conducting stress-testing. If market perception will drive a bank to do all it can to avoid dipping into the bufer, it is likely to reduce lending to do so, if necessary. If a signifcant part of the banking system is similarly afected and responds in the same way at the same time, a system-wide contraction in the supply of credit could result – even with the banking system well-capitalised. Hence the importance of communication from the authorities on this point.

However, note that communication alone is not enough. The market needs to believe that a bank can use some of its CCB to absorb losses and still be worthy of funding.

Next, the Commission’s proposals on the leverage ratio:

[Previously] the Commission recommended that the 7% Basel III baseline for the ratio of equity to RWAs be increased to 10% for large ring-fenced banks. This would also increase the Basel III baseline for the ratio of Tier 1 capital to RWAs from 8.5% to 11.5%.

In order that the leverage ratio provides an equally robust backstop for large ring-fenced banks it should be increased proportionately from 3% to (11.5/8.5) x 3% = 4.06%… an abrupt change in regulatory requirements
when a bank crosses a size threshold should be avoided by increasing the minimum leverage ratio from 3% to 4.06% on a sliding scale as the RWAs-to-UK GDP ratio increases from 1% to 3%.

On non-equity capital:

The Commission recommends that the SRR [special resolution regime] should be supported by giving the resolution authorities two complementary bail-in powers available for use in resolution.

First, the authorities should have a ‘primary bail-in power’ to impose losses in resolution on a set of pre-determined liabilities that are the most readily loss-absorbing. This should include the ability to be able to write down liabilities to re-capitalise a bank (or part thereof) in resolution… the class of (non-capital) liabilities that bears loss most readily is long-term unsecured debt. The Commission’s view is therefore that all unsecured debt with a term of at least 12 months at the time of issue – ‘bail-in bonds’ – should be subject to the primary bail-in power…

Second, the authorities should have a ‘secondary bail-in power’ that would allow them to impose losses on all unsecured liabilities beyond primary loss-absorbing capacity (again, including the ability to write down liabilities to re-capitalise a bank) in resolution, if such loss-absorbing capacity does not prove sufficient…

The minimum ratio of primary loss-absorbing capacity to RWAs required of a ring-fenced bank should therefore be increased from 10.5% (the minimum amount of primary loss-absorbing capacity required under the Basel III rules) to 17% on a sliding scale as the RWAs-to-UK GDP ratio increases from 1% to 3%.

Thus, roughly, we have a 10% equity requirement and a 7% bail-in bond requirement for the largest UK banks. This is however not a at-all-times requirement. Sensibly, Vickers says

A minimum primary loss-absorbing capacity requirement should be regarded as a bufer, rather than a hard minimum. (Imposing it as a hard minimum might result in a G-SIB with 16.5% of primary loss-absorbing capacity – much of which could be equity – being put into resolution. This would obviously not be desirable.) The consequences for falling below the minimum should therefore not be a breach of regulatory threshold conditions. Instead, restrictions should be imposed on a bank’s ability to pay out discretionary distributions such as dividends and bonuses (as happens when a bank falls into its CCB – see Box 4.2). If a bank’s ratio of primary loss-absorbing
capacity to RWAs falls below the minimum, this means the bank can continue to
operate (although its supervisor would no doubt expect to see evidence of a
management plan demonstrating how the bank would restore its level of primary
loss-absorbing capacity in due course).

What we end up with, then (once you include an extra 3% resolution buffer for investment banks), is this:

Vickers Capital

Next up, some interesting disclosures from Chapter 7. I know, you can hardly wait…

2 Responses to “Vickers outside the ring fence: part 2”

  1. […] So far we have seen that the Vickers Commission proposals are reasonably penal in terms of both the levels of capital they suggest for the largest UK banks and the concomitant leverage ratio. […]

  2. […] So far we have seen that the Vickers Commission proposals are reasonably penal in terms of both the levels of capital they suggest for the largest UK banks and the concomitant leverage ratio. […]