UK’s bubble-prickers seek iron grip on banks

March 23, 2012

By Peter Thal Larsen

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Britain’s bubble-prickers are aiming high. The Bank of England’s new Financial Policy Committee, which is charged with averting future crises, has asked the government for sweeping powers to rein in banks, insurers and fund managers. Even if it doesn’t get everything it wants, the FPC will clearly have muscle. The snag is that it has few ideas for solving the most pressing current problem: excessive risk aversion.

Most of the FPC’s wish list is pretty sensible. It wants to set and vary banks’ counter-cyclical capital buffers – the tool specifically designed to allow regulators to “lean against the wind” of excessive exuberance or caution. It also wants to control the size of banks’ balance sheets by setting the leverage ratio, which measures equity as a proportion of total assets. And it wants to be able to apply its powers to any regulated entity, including insurers and investment funds. That should allow it to quickly whack risk-taking that shifts from banks to other parts of the system.

More troublesome is the FPC’s desire to vary capital ratios for lending to different sectors. Such micro-management could undermine investors’ already-fragile confidence in the accuracy of banks’ ratios. It is also hard to reconcile with the European Commission’s efforts to ensure that new capital rules are applied consistently across the European Union.

True, the proposed tool would have allowed regulators to rein in banks’ property lending during the last bubble. However, the same aim could be achieved more easily by capping loans as a proportion of the value of a property, or a multiple of the borrower’s income. Sadly, the FPC appears to have concluded that demanding such powers is a political non-starter.

A more pressing problem, however, is that the FPC’s proposed powers are asymmetric: they are much better suited to tackling exaggerated optimism than in countering the undue caution currently gripping Britain’s economy. This tension is evident from the minutes of FPC’s latest meeting: it concluded that UK banks should raise capital to further strengthen their buffers, even as the government attempts to stimulate the flow of credit to small businesses and housebuyers. Even if the FPC gets the tools it wants, it could be years before they are used.

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