FSA warns of trading book capital hikes

LONDON (Reuters) - Banks will have to set aside far larger amounts of capital to cover trading risks in future, the country’s top financial watchdog said on Tuesday in a move backed by Europe’s top bank.

Policymakers applying lessons from the credit crunch are focussing on a mix of better supervision of risk and tougher, so called ‘capital charges’ on banks to curb excessive risk taking.

In his toughest speech yet on the subject, Adair Turner, chairman of the Financial Services Authority, said bank capital rules must be radically altered as improving supervision will be imperfect at best in spotting “bumps on the road.”

“The most fundamental change is to create a financial system with more shock absorbers, and the shock absorbers of the banking system are capital and liquidity,” Turner told a British Bankers’ Association (BBA) conference.

“Capital requirements against trading books need to be significantly increased,” Turner said.

There was also a need to go back to basics and look at the different risk characteristics of different elements of the trading book and think through appropriate approaches from first principles, Turner added.

Mandatory capital charges for assets held on a bank’s trading book are generally lighter than for those held on the bank’s main balance sheet.

Bankers say if the capital charge becomes higher on the trading book than on the bank’s main book, some banks will exit trading and this would allow a small group of super banks with deep pockets to dominate the sector.

Turner said the Basel Committee of global banking supervisors, which drew up the current bank capital rules, is also planning to make changes that would increase trading book capital by “several times.”

Stephen Green, chairman of HSBC HSBA.L, Europe's biggest bank, said major changes are needed to trading book capital to restore investor trust.

“While there may be room for debate on the specifics, the need for a significant increase in the capital required is clear,” Green told the conference.

“There’s plenty of scope for debate on whether this is across the board of trading businesses or focussed on particular areas,” Green told Reuters after his speech. He said, for example, currency trading activities may not need extra capital but areas involving credit would do.


Financial lawyers said Turner’s stronger push on capital requirements risked unintended consequences.

“He is hardening his stance on capital requirements but the significant risk is that over time that will create bigger banks and therefore the ‘too big to fail’ problem is exacerbated,” said Michael McKee of DLA Piper law firm.

The problem centres on the “moral hazard” that banks considered too big to fail will pursue risky activities knowing the authorities will shore them up in times of crisis to avoid destabilising the wider financial system.

Turner said the best option for dealing with the too big to fail issue was to simply demand that larger banks have higher capital requirements to reduce the probability of failure to extremely low levels.

“High equity capital levels are, I think, an answer to the moral hazard problem which also recognises systemic realities,” Turner said.

The BBA said banks were already holding more capital then they were before the crisis that began unfolding nearly two years ago, and twice the amount laid down by the Basel rules.

British junior finance minister, Paul Myners, said the UK government will publish its proposals on future financial regulation next week, which is set to touch on bank capital.

“An efficient system can never rely on regulation alone. Good corporate governance and stewardship are key.. We’ve possibly become too slavish in our devotion to the very simplistic model of shareholder value,” Myners said.

Reporting by Huw Jones; additional reporting by Steve Slater; editing by Richard Hubbard