'Fire sale' risk with Bank capital approach, says Vickers

By Howard Mustoe
Business reporter

image source, AFP

Sir John Vickers, who was asked to construct a safety plan for Britain's banks in the wake of the financial crisis, has warned regulators over hasty bank asset sales.

Parliament is investigating whether UK banks have the capital means to keep going during a shock and Sir John and the Bank of England gave evidence.

The Bank said some lenders could help themselves by selling off assets.

Sir John has warned that this could lead to a "fire sale".

Sources close to the Bank insist that it monitors and must approve plans for asset sales during economic stress to show that the sales could still be beneficial.

During the financial crisis, bad loan losses chewed through banks' capital reserves and lenders including Royal Bank of Scotland and Lloyds had to be given new capital by taxpayers, making them part-nationalised.

Price risk

Parliament's Treasury Committee, which has the responsibility of examining the government's work on economic and regulatory matters, is aiming to discover whether new plans for banks will mean they can avoid needing taxpayer help the next time trouble calls.

As part of evidence published earlier this month, the Bank of England said one way for a bank to bolster its capital when it was facing low expected profitability due to high costs rather than poor lending, was to sell some of its loans.

Sir John has replied in a letter seen by the BBC, and said this plan may work if only that one bank is in trouble.

However, he warned that during another widespread crisis, this may be seen by other banks and investors as a so-called "fire sale", where the assets, or loans, would be considered damaged goods by potential buyers and end up selling at a knock-down price.

'Insurance Policy'

"Systemic crisis risk is the principal risk that regulation should guard against," Sir John wrote in the letter to the Bank. "The prudent stress test question, then, is whether the bank can meet its obligations without resorting to asset sales. It is not whether it can do so on the assumption that assets can be sold at good prices."

The bank has previously said that a sale may not be allowed if "the sale of a business unit may not be executable in the stress scenario or may not yield the full capital benefit the bank expects."

"Sir John's letter is puzzling and wrong. The Bank of England conducts rigorous stress tests of major banks. In those tests, any bank that assumes it would sell assets in a stress must also assume that they would be sold at very low prices. Such sales do not help banks withstand stresses," the Bank said in a statement.

Sir John, who has served as chief economist for the Bank of England and is now professor and warden of All Souls College, Oxford, has cautioned his former employer before over its approach to capital.

Capital is considered vital to a bank's safety, as it serves to protect it from sudden losses. It comes in many forms, but the most common is funding from shareholders, who expect a hefty return on the risk they are taking.

Last year, Sir John said the central bank needed to demand a deeper capital buffer from the banks, calling it an "insurance policy" against harder times and deserving "full cover".

The exchange is part of a wider debate over how banks should be managed and policed and whether they are still too big to be rescued by the private sector.

Stricter accounting rules, stress tests, stricter liability for bank directors and plans to dismantle failing banks have at various stages been discussed as the solution.

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