Banks will have to retain more capital than currently required, making them less profitable but safer, under landmark proposals set out today by Britain's financial regulator.
In a report aimed at identifying ways of preventing a repeat of the global banking crisis, the Financial Services Authority (FSA) also called for a new European regulatory body and a global agreement on how international supervisors might spot and address risks to financial stability.
The report, commissioned by Prime Minister Gordon Brown at the height of the banking meltdown last October, suggested banks hold a minimum core tier one capital ratio, a key measure of financial strength, of 7 per cent during the peak of the economic cycle. Current British and international guidelines set out a minimum core tier one ratio of 4 per cent.
This would make banks less profitable, but would equip them to weather storms such as the credit crunch, which has in the past 18 months caused the collapse of Wall Street giants Lehman Brothers and Bear Stearns, and triggered the full or partial nationalisation of five major British lenders.
“There is a strong prima facie case that minimum bank capital requirements should in future be significantly above those which have applied in the past,” the FSA said.
“The future world of banking probably will and should be one of lower average return on equity but significantly lower risk to shareholders as well as to depositors.”
The regulator also proposed that banks build up their capital reserves during boom times, creating a buffer that can be run down when the economy sours. This would help soften the impact of a recession by ensuring that lenders can maintain the supply of credit as the economy slows.
The FSA also put pressure on its global counterparts to agree a deal on significant increases in capital held against potential losses on bank trading books within a year.
The report, authored by FSA chairman Adair Turner, called for the creation of a new European Union regulatory body which would help national supervisors identify risks to the financial system caused by changes in credit availability, debt levels, and asset prices.
However, national regulators would retain primary responsibility for supervising firms in their jurisdictions.
Reuters