Edited by Thorsten Beck - Vox

The Future of Banking
their traditional banking mortgage books themselves. Ring-fencing, by itself, would not
necessarily have reduced these exposures.
In this regard, it is useful to consider the capital requirements announced in the Vickers
report. Banks will be required to hold equity capital of at least 10% of risk weighted
assets in the ring fenced business, and both parts of the bank will be required to have
total loss absorbing capital of at least 17% to 20%. This seems substantially higher than
what Basel III has proposed. The requirements are in fact more in line with the levels of
capital requirements that Switzerland has been implementing. The requirements are also
somewhat higher than those tentatively discussed in the US, though we are waiting for
further clarity on what will be the systemic capital surcharge for systemically important
financial institutions in the US under the implementation of the Dodd Frank Act.
The key point is that whatever the capital requirements – 10% and 17% or 18% – it is
as a function of risk weighted assets. The fundamental question that has not been put
on the table is, are the current risk weights – and the overall framework for determining
them – right? In particular, we have very low risk weights on residential mortgage
backed securities. What that did was actually increase the lending to the residential
mortgages as an asset class. Endogenously, therefore, ie, as a response to the capital
requirement itself, the residential housing became a systemically important asset class.
However, all through the crisis, and even post crisis, we have continued with a relatively
attractive risk weight on this asset class – in spite of the fact that the crisis effectively
told us that what banks were holding as capital against these assets was not adequate
from a resiliency standpoint as far as bank creditors and investors were concerned.
We are in fact facing a similar problem with respect to the sovereign debt holdings of
the troubled countries in Europe. Their bonds are being held by banks all over the world,
especially in other Eurozone countries. These bond-holdings have so far, as long as they
are in banking books of banks (and hence, not ring-fenced), not received substantial
haircuts in regulatory capital assessments. In turn, banks have not been asked to raise
substantial capital against them (though we might finally see some pan-European bank
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