27 April 2012

FSA/Bailey: Basel III – the big issues

Andrew Bailey, FSA Director of UK Banks & Building Societies, said the simple answer that wide-ranging reforms are being undertaken because we have had a major crisis, is not good enough as an explanation: it explains the timing of the reforms, but the substance of them requires more explanation.

Principles on which Mr Bailey focuses:

• First, achieving a stable financial system will in turn enable the development of a strong, competitive system, and likewise will foster the strength of financial centres. Financial stability and competitiveness are not fundamentally in conflict.
• Second, the other key objective of the reforms is to achieve the stability of the financial system without recourse to public money as the buttress – both implicit dependence and in bad states of the world explicit dependence.
• Third, lack of clarity in this respect is not in Mr Bailey's view conducive to a well-functioning market economy.  

There are at least two complications here:

First, quite sensibly we want supervision to be judgemental, in other words to embody sensible flexibility.  Likewise, we think that exercising judgement is in large part about applying the Basel III framework on a forward-looking basis in order to assess the vulnerability of institutions to big risks. 

The second complication in terms of clarity around the objectives of supervision is that we are applying the Basel III changes as a transition over a number of years. This is wise in terms of the consequences of the change and their impact on the real economy, but it prompts uncertainty over how Augustinian authorities may be in their approach to transition.

The key point here is to minimise uncertainty and thus to support a functioning market economy. All of this should be measured on a Basel III basis, and supported by a leverage ratio, as the ICB recommended. And, there should be clear liquidity standards. Switching to the Basel III capital standard will require a transition where banks do restructure their balance sheets and retain more earnings while they transition. Providing the objectives are well understood, Mr Bailey believes the banks can make this transition. But he does accept the challenge that the process needs to be well understood – markets are more likely to give banks credit for their prudential buffers of capital and liquid assets if they understand the end-points and the ways in which we as supervisors will exercise our judgement.

Full speech

© FSA - Financial Services Authority