BOE Announces its Position on Capital under CRR IV

Last week BOE’s Prudential Regulation Authority presented its Statement on Strengthening capital standards; which provides clarity on bank capital rules after the consultation of August last year. It was about time, given that the new capital rules under CRR IV enter into force in about one month from now. With a 7% CET1 requirement, the BOE presents a relatively modest position on capital requirements; Sweden, for example, once announced 12%. Perhaps as a result of its modesty, the BOE did not budge a lot after having perused the consultation feedback. 

Three observations on Pillar I decisions of the BOE:

1) BOE imposes a 3% Tier 1 Leverage Ratio on  the largest eight banks, thus not giving in to recent pressures to apply a 4% Leverage Ratio requirement. The 3% requirement may look tough, as it enters into force next month. However, note that Tier 1 may include hybrid capital securities. This is capital of the weaker kind, see my post on the leverage ratio. Moreover, on 1 January 2014, the new Tier 1 deductions will not kick in in full, they will be phased in. Consequently, meeting the 3% Tier 1 Leverage Ratio requirement now should be doable.

2) The BOE offers one goody, perhaps as a sign that it responded to the consultation feedback. This goody is the phase-out of the waiver for the deduction of holdings in financials at the solo level. The phase-out of the solo waiver replaces its proposed immediate elimination. The BOE decided that, from next month on, banks should deduct 50% of significant investments in financials. From 1 January 2015 the deduction increases to 100% in steps of 10% each year. Note that this decision respects the hard-fought thresholds for deferred tax assets (now blatantly dodged by Italy and Spain) and deduction thresholds for investments in financials (a wicked French idea).

I think the elimination of the solo waiver has clear merits, as the waiver discouraged bank subsidiaries from up-streaming capital to the parent holding bank. In a time of crisis, parent holding banks need capital, but they cannot always access the capital of their foreign subsidiaries. This is because in a time of crisis, a foreign bank supervisor will not allow a subsidiary to have its capital sucked away by the – then black hole – parent holding bank. In addition, the solo waiver may have led some bank subsidiaries to invest in extremely risky assets.
That will all now come to an end, albeit gradually, good. The result is that foreign subsidiaries of UK banks will become thinly capitalized, limiting their autonomy to play. In fact, this works as a curfew imposed by the parent holding bank on its subsidiaries. 

3) A true non-surprise is BOE’s announced treatment of unrealised gains. Some reporters thought the BOE relaxed its position on unrealised gains. However, this decision is in line with CRR IV and with Basel III. Both allow the inclusion of unrealized gains in capital – even though this is imprudent; and despite EBA’s advice to the European Commission to eliminate some unrealised gains from capital (see my earlier post on EBA’s advice here). 

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