Peter Eckley and Liam Kirwin.
In the world of bank capital regulation, minimum requirements grab all the headlines. But actual capital resources are what absorb unexpected losses. Banks and building societies typically hold resources substantially in excess of requirements – called the capital surplus. One reason is to avoid breaching the minimum due to unforeseen shocks. Another is to build resources in anticipation of requirements arising from growth or regulatory change. The chart shows how capital surpluses (on total requirements including Pillars 1 and 2, and all types of capital) have varied in recent decades. It is based on historical data from regulatory returns.
Before the financial crisis, the surplus was stable, with a median around 4.5 percentage points of risk-weighted assets. After the crisis, the median has risen steadily. Building capital ahead of increasing requirements is likely a major driver (Basel III is being phased in progressively, and won’t be fully in force until 2019). Interestingly, the so-called ‘big 6’ banks have gone from economising on their capital surplus relative to other banks and building societies to being broadly in line with the pack.
The upshot is that, in the wake of the financial crisis, UK banks and building societies have become substantially more safe and sound than a simple calculation of new requirements plus the typical pre-crisis surplus would suggest. The question remains: where will the capital surplus settle once Basel III has been fully phased in? Watch out for a chart like this in 2020!
Update 20/12/2016: The data used to generate the chart can be found here.
Peter Eckley and Liam Kirwin work in the Bank’s Policy Implementation & Strategy Division.
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Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.