Out-Law News 3 min. read

Treasury consults on Bank of England's new financial stability powers


The Government has published the details of planned new powers intended to give the Bank of England the ability to promote financial stability, including the ability to impose tougher capital requirements on troubled sections of the market.

The Financial Services Bill, which is currently before Parliament, will create a Financial Policy Committee (FPC) within the Bank of England as part of its fundamental reform of financial services regulation in the UK. The FPC will identify and address potential risks to overall financial stability, rather than play a role in the day to day oversight of firms, and will have the power to make recommendations to regulators, the Treasury and other parts of the Bank.

"This Government is committed to reforming the failed system of financial regulation," Greg Clark, Financial Secretary to the Treasury, said. "In establishing the Financial Policy Committee, the Government is creating a strong, macro-prudential authority that will identify and address potential risks to stability in the financial system. But to be effective it must have the appropriate tools. Today we are consulting on our proposals for what those tools will be."

Macro-prudential regulation considers the aggregate behaviour of financial services firms, as opposed to micro-prudential supervision which deals with the behaviour of individual firms. The FPC will be charged with overseeing the financial system as a whole, identifying potential risks to its stability and taking concerted action to address them. It will also be able to issue directions in certain areas to the Prudential Regulation Authority (PRA), a separate micro-prudential regulatory body within the Bank which will deal with the day-to-day running of firms.

An interim Financial Policy Committee was created early last year as a committee of the Court of the Bank of England to take on a limited macro-prudential and preparatory role before any former legal powers were created. The tools outlined in the consultation document are based on this interim committee's recommendations to the Treasury, which it published in March.

At the time, the interim FPC highlighted other areas, such as the introduction of liquidity requirements, which could become the subject of future powers of direction. The Government said that it "did not intend to include" this power, referring to the percentage of a bank's assets which must be held in a form that can be easily converted to cash, among the FPC's initial tools as it was "waiting for international standards to develop". However, respondents to the consultation are entitled to make their views known at this stage.

The consultation (66-page / 1.4MB PDF) sets out three tools that the FPC will be able to use to address systemic risks to the financial system in the UK. It proposes giving the FPC control to set the UK's 'counter-cyclical capital buffer', requiring national banks to hold extra capital against their liabilities at times of greater risk. A further sectoral 'direction-making' power will allow it to impose tougher capital requirements against individual sectors to address particular risks, for example over-exposure to commercial property lending or residential mortgages.

The third proposed tool, giving the FPC the power to set a leverage ratio cap and very this over time where necessary, will come into force when international standards are in place. Any leverage ratio, limiting the amount that banks are able to borrow, would be a separate requirement from and compliment to risk-related capital buffers.

According to the consultation, the Government intends to legislate so that the FPC's powers of direction in relation to the capital buffer and sectoral capital requirements can be applied to larger credit institutions - including banks and building societies - and investment firms. The smallest investment firms, such as small stockbrokers, will be "carved out" from the FPC's powers as "their use in relation to these small, low-risk firms, could be disproportionate".

Under the international banking agreement known as Basel III, more stringent capital requirements for banks will be phased in between 2013 and 2022. Banks will have to increase both the quantity and quality of capital they hold, while accounting for higher levels of risk-weighted assets. The consultation effectively gives the FPC the responsibility for ensuring that the UK complies with its international requirements.

The counter-cyclical capital buffer, which is one of the macro-prudential tools which will be introduced under the Basel III agreement, will be phased-in in parallel with micro-prudential capital requirements for individual banks between 1 January 2016 and the end of 2018, becoming fully effective on 1 January 2019.

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