Large UK banks will face ‘systemic risk buffer’ of up to 3%, says FPC

The new systemic risk buffer (SRB) will be introduced in “broadly the same” form as that which was consulted on by the FPC in January, according to a framework document published by the FPC. The Bank of England committee has, however, proposed one recommendation to the Prudential Regulation Authority (PRA).

“The crisis was an example of how the economy can be seriously damaged when [large banks and building societies] become distressed and restrict lending to the economy,” the FPC said in its framework. “It is therefore important that such institutions carry higher levels of capital so that they can absorb losses in stress and continue to maintain critical financial services to the real economy, particularly the provision of credit.”

“The [SRB] increases the capacity of UK systemic banks to absorb stress, thereby increasing their resilience relative to the system as a whole. This reflects the greater damage these firms would cause to the economy in the event their buffers of equity were exhausted,” it said.

The introduction of the SRB takes forward an element of the recommendations of the Independent Commission on Banking (ICB), which was chaired by Sir John Vickers and set up to make recommendations for structural reform of UK banks following the financial crisis of 2008. It imposes additional capital requirements on the largest and most risky UK banks, which will be applied on an individual basis by the PRA.

The SRB will be introduced alongside the ring-fencing rules, which from 2019 will require banks that take in more than £25 billion in ‘core’ deposits from individuals and small businesses to formally separate those activities from their riskier investment banking activities.

In its framework document, the FPC has confirmed that it will set the SRB at 0% for banks with less than £175 billion in assets. Above this level, the buffer will gradually increase to 3% of risk-weighted assets for those firms with more than £775bn in assets. Based on current plans, the FPC expects the largest institutions to which the requirements will apply to have a 2.5% SRB in place, as none of them meet the £775bn threshold at present. One response to the FPC’s consultation on its proposals recommended that all banks subject to the ring-fencing rules be required to hold a 3% SRB.

The FPC said that imposing higher systemic buffers on larger firms would reflect “the greater economic costs of their distress or failure”. It intends to use firms’ total assets as a “proxy” for their systemic importance when calculating the size of the buffers, as this “captures the most important determinants of systemic importance while remaining relatively straightforward to implement”, it said.

Those firms to which global systemic buffers also apply would be required by the PRA to ensure that the new buffer was “proportionately distributed” between the ring fenced and non-ring fenced parts of the bank, according to the FPC. This would “ensure that there is sufficient capital within a consolidated group, and distributed appropriately across it, to address both global and domestic systemic risks”, according to the framework.

The FPC is under a statutory duty to review the SRB framework every two years, which means that it will first be required to do so in 2018, one year before the requirements come into force, according to the document. Amendments to the rules may be made at this stage, and the FPC will also consider any new evidence that emerges from the House of Commons Treasury Committee’s new inquiry into capital standards for banks, the FPC said.