Sants: We wanted banks to hold more capital

Hector Sants Image copyright Getty Images
Image caption Mr Sants has made it clear that he plans to take a more hands-on approach to banks

Britain's top financial regulator is today heralding an era of more intrusive and intensive supervision of banks, to minimise the danger that we'll see another banking crisis as acute as that of 2007-8.

Hector Sants will be unveiling the new system for monitoring the risks taken by banks at a conference later today about the philosophy and functions of the Prudential Regulatory Authority (PRA) - which is the body being created to supervise banks from 2013 onwards.

The PRA, which will have around 1,000 staff, is being created from the break-up of the current City watchdog, the Financial Services Authority, which was ordered by Chancellor, George Osborne.

In an interview with me, Mr Sants - who is chief executive of the FSA and will also run the PRA - said that the PRA will be relatively more aggressive in its oversight of banks, to ensure that their behaviour isn't jeopardising the stability of the financial system.

This decision to supervise banks more intensively is in part precisely because the FSA expects to lose the international battle to impose significantly higher capital requirements on the world's biggest banks, what are known as the G-SIFIs, or globally systemically important financial institutions (the likes of HSBC, Barclays and Royal Bank of Scotland).

"The presumption in our paper [on the creation of the PRA] is that we would have liked more capital than we are likely to get", he said. "So supervision becomes more important".

'No secret'

The point is that the more capital banks are forced to hold as protection against potential losses, the more stupidly they can be permitted to behave - because they would be able to absorb the losses generated by their recklessness and stupidity without being in danger of collapsing or asking taxpayers for help.

So the more capital that banks hold, the more relaxed the regulator can be about how they conduct themselves.

The corollary, said Mr Sants, is that the less capital they have, the more that there is an obligation on the regulator to keep their behaviour on a tight rein, to minutely examine all the significant risks they run, and to veto any initiatives banks might wish to take which could precipitate disaster.

Mr Sants said it was "no secret" that the FSA and the Bank of England had been arguing on the international Basel Committee and the Financial Stability Board for a bigger increase in the capital held by G-SIFIs or the mega-banks than was desired by regulators from other countries, such as France and Germany.

He refused to be drawn on what the final outcome would be, but he did not deny that expectations of banks such as HSBC that they'll be forced to hold what's known as core tier one capital equivalent to around 10% of risk-weighted assets are in the right ballpark - or about 3 percentage points more than the new 7% minimum for all banks.

If, as Mr Sants implied, the new G-SIFI capital increment settles at around 3%, that will be significantly less than the optimal level calculated by David Miles of the Bank of England's Monetary Policy Committee in an influential paper. Mr Miles said that the optimal ratio of core tier one equity capital to risk-weighted assets would be 19%.

The big banks will breathe a sigh of relief that 10% is expected to emerge as the new norm for their core capital ratio - partly because they have taken pre-emptive action and already meet that target.

However, they will be less pleased that Mr Sants makes clear that there is a price for them of winning that argument - which is that he and his colleagues at the PRA will be spending rather more time bossing them around, and circumscribing their activities, than they might like.

Risky business

By the way, it is not just the level of capital held by banks which determines how intrusive a bank regulator needs to be. What also matters is whether so-called resolution procedures - emergency action when a bank gets into difficulties to break the relevant bank up, in order to protect depositors and the money transmission system - are perceived to be so robust as to minimise the potential for financial crisis.

Mr Sants said that he and his colleagues are determined to make resolution procedures as effective as possible - and they are currently running simulations with the biggest banks to verify how resolution would operate in practice for them.

But although he is confident that effective resolution procedures will play an important role in helping the PRA to meet its single objective, of "contributing to financial stability through oversight of individual firms", resolution can never be an alternative to hands-on supervision by regulators.

Mr Sants insisted however that he had not given up altogether on the importance of competition and market discipline in preventing banks from taking crazy risks - even though market discipline singularly failed in the run up to the financial crisis of 2007-8.

He disclosed that a decision has been taken for the PRA to publish all the regulatory data supplied to it by banks - what is known as banks' regulatory return - so that banks' investors and creditors will be able see for themselves whether the banks are taking excessive risks.

This will be seen as an admission by Mr Sants that the financial results currently published by banks don't tell the whole story about the risks they take.