The bank leverage ratio is sensible – but we should be wary of Balkanisation

 
Anthony Browne
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MARK Carney and George Osborne, the two most powerful men in the British economy, swapped letters on Tuesday about the tools they needed to create a stable banking sector. They agreed that the Bank of England’s Financial Policy Committee will consider whether the Bank should be able to set the amount of money UK banks must hold against their total assets – the leverage ratio – ahead of the international timeline.

Carney has seen first-hand the benefits of banks holding reserve funds on top of the capital they already hold against their risk-weighted assets. Before he took office, he told the Treasury Committee that the leading reason Canadian banks fared so well through the crisis was that they had a leverage standard. The same would be true for the UK, he has suggested. It will make our banks safer.

It is far from certain whether the Canadian experience has lessons for the UK, but the introduction of a leverage ratio is still sensible and the banking industry fully supports it. The letters, however, also give us a valuable insight into the two men’s attitude towards a broader concern.

Carney said the Bank’s review would only start once the exact definitions for the leverage ratio had been agreed internationally by the Basel Committee on Banking Standards. This should please London’s global banking community and points to an awareness of a worrying trend in how national regulators have responded to the crisis. To quote our chairman Sir Nigel Wicks, each country has used its own fire service to put out a global financial fire.

Local regulations are no bad thing. They allow tailoring to market conditions and reduce the risk of contagion. But there is a danger that, without international standards, banks have to navigate the equivalent of “spaghetti junction” on the global regulatory highway. The national-led programme of reforms is also causing regulatory divergence, often referred to as “Balkanisation”. One effect is increased complexity. This is leading to higher compliance costs that could be passed on to customers, as we pointed out in our recent report Beyond Boundaries. Another impact is reduced competition, as barriers to entry provide opportunities for arbitrage.

Carney and Osborne seem aware of these dangers. The governor even used a recent speech to highlight the importance of maintaining global capital markets and inter-dependent banking sectors. The retreat from globalised markets threatens London’s status as the global booking house for wholesale banking and could cost the UK economy dearly.

Some in the UK are arguing to move beyond the 3 per cent leverage ratio proposed by the global Basel III rules. This is unwise. A rate of 4 per cent could create problems for both banks and customers. The leverage ratio could cease to act as an additional “backstop” that enhances financial stability. The higher rate could create perverse incentives, whereby banks prioritise riskier lending over mortgages and other safer forms. Not only could the cost of mortgages increase for customers, it is the exact behaviour policymakers are trying to avoid.

But Osborne and Carney appear committed to doing everything they can to promote regulatory convergence. We should only accept a higher leverage ratio on an accelerated timetable if there is clear evidence that it benefits the UK economy.

Anthony Browne is chief executive of the British Bankers’ Association.