UK aims to Bolster Capital Rules

The U.K.'s Financial Services Authority proposed strengthening its rules that govern the amount and quality of capital that banks in the U.K. need to hold against potential losses as part of an effort to implement changes to European Union rules.

The proposals are expected to result in a £33 billion ($53.69 billion), or 5%, increase in the total amount of capital held by banks, with the bulk of this required to be held by the start of 2011, the FSA said.

The new rules will increase costs for banks, which will need to raise some of this extra capital, using higher-quality instruments than they have used in the past, from investors who may be unwilling to risk exposure to the banking sector in the wake of the financial crisis, regulatory observers said.

The FSA's new rules are designed to ensure that banks hold more capital against proprietary trading activities and securitization deals they invest in so they can better weather future financial crises. They are in line with changes to international capital rules set by the Bank for International Settlements.

The BIS is due to publish a draft proposal by the first quarter of 2010 on reforming its Basel II capital rules for the world's largest banks.

The FSA has suggested boosting the capital requirements for banks' trading-book exposures so they better reflect potential losses during times of financial turmoil, as well as improving the risk management of securitization exposures, partly by allowing firms to invest only in deals in which the originator retains a 5% economic interest.

It also has indicated it will impose higher capital levels for resecuritization deals in which an extra layer of complexity is added by repackaging existing asset-backed securities into new securitizations.

The new rules would limit a firm's lending to any one counterparty to 25% of its capital and upgrade standards of disclosure about capital levels to increase confidence in the financial sector, the FSA said.

They also would bring the U.K. into line with EU criteria for assessing the eligibility of hybrid capital to form a core part of the firm's overall capital base by specifying the flexibility of payments and loss-absorbency they must possess to be accepted, it said.

The FSA said the new capital requirements will cost firms £6 billion a year.

The new rules, in tandem with the FSA's plans to force banks to hold buffers of government bonds, will force many banks to alter their business models so they take on less risk from trading and investments in structured products, according to some regulatory consultants.

"This will change business models," said Selwyn Blair-Ford, senior domain expert at FRSGlobal, a risk and regulatory reporting company. "If I were a bank I would be questioning the ability to maintain certain business lines because of the increased costs of capital and liquidity."

Banks will also incur costs from having to raise capital from investors by issuing higher-quality instruments that absorb losses more efficiently.

"You've got firms at the moment which will be financing themselves with interest-bearing long-term bonds who will find that capital is just not acceptable anymore," said Blair-Ford. "The reason they had taken that route was because investors weren't willing to take raw equity."

The British Bankers' Association would only say that it is working with the financial authorities on the development of new capital rules.

"This is part of an international process to develop new rules for the treatment of capital," said Brian Mairs, a spokesman for the BBA.

UKCIG News, December 2009