UK banks are holding excessive capital reserves that could instead be directed towards lending and economic activity, a senior Bank of England regulator has said. David Bailey, executive director of Prudential Policy at the Bank of England, told City AM that the watchdog had begun talks with international counterparts on simplifying the way banks’ capital is structured, with the aim of freeing up billions of pounds in stored cash.
Bailey said banks were choosing to ‘hold quite significant management buffers over and above our regulatory requirements.’ He added: ‘The size of the buffer we see is larger than we’d expect.’
What is driving the excess
Under current rules, lenders must maintain a multi-layered stack of capital cushions, covering strict legal minimums, buffers specific to major domestic firms, and overall leverage caps. On top of those, banks voluntarily hold additional discretionary cash, known as management buffers, to avoid accidentally breaching the baseline requirements.
Bailey said several factors feed into those decisions, including a ‘rainy day fund, an opportunities fund [and] rating agency requirements.’ The Prudential Regulation Authority (PRA), the UK’s main banking watchdog, was now looking to give firms ‘certainty’ over their requirements, he said, so that more capital could flow into the real economy. ‘That capital they’re holding could be deployed for supporting their customers and households,’ he said. ‘If you’re interested in growth, that’s viable economic activity they could be supporting.’
In July, the Bank’s Financial Policy Committee (FPC) set out a proposed overhaul of the capital buffer system, centred on a ‘single buffer that is releasable in stress.’
Industry criticism and the political dimension
The banking industry has been pressing the case for reform. A report from the Association of Financial Markets in Europe (AFME), whose membership spans more than 150 global banks, among them the UK’s big four, described the UK’s leverage ratio as a ‘clear instance of gold-plating.’ The AFME said the rule ‘penalises good risk management and creates incentives to invest in higher risk assets.’
Bailey said he did not ‘recognise that description of our regime,’ pointing to recent work including the FPC’s assessment of the ‘optimal capital’ level in the UK banking system. ‘If you’ve got capital set too low, then you run the risk of a financial crisis. Those things are expensive… and have a long-term scarring effect. But also if you set capital too high, you can strain viable and productive economic activity… what we’re looking for is the sweet spot so we get the right level of resilience in a way that supports firms doing activity.’
Conservative leader Kemi Badenoch has previously criticised what she described as ‘buffer after buffer after buffer’ imposed on banks, pledging that a future Conservative government would bring ‘capital requirements back in line with our competitors.’ The authority to set those requirements lies with the FPC, meaning any government seeking to alter them would need to legislate first.
Asked about Badenoch’s position, Bailey said: ‘We work with whatever parliamentary mandate we’re given, and of course would work with whatever government we have at any particular time.’ On international comparisons, he said the Bank’s detailed analysis showed the UK regime was ‘comparable with the EU in terms of the outcomes it produces for overall capital levels, and below the US,’ adding that the US had made ‘a number of changes’ bringing it ‘more into line with where [the UK] and EU are.’
Bailey is set to leave the Bank of England at the end of October. Katharine Braddick, an executive at Barclays, was named as the successor to outgoing PRA chief Sam Woods in February.
