Capital adequacy and liquidity regulation are in need of urgent review as a result of the financial crisis, according to the UK's Financial Services Authority (FSA).
The FSA yesterday released its annual Financial Risk Outlook (FRO), which outlines major risks facing firms, consumers and the regulatory system as a result of the financial crisis. Alistair Darling, the UK's Chancellor of the Exchequer, has asked the FSA's chairman Lord Adair Turner to undertake a comprehensive review on the future of bank regulation. According to yesterday's statement, the most significant parts of that review will centre on capital adequacy and liquidity regulation.
The regulator believes capital adequacy rules need to be reviewed to increase capital held against trading book assets and to mitigate market risk, and also stressed the need to introduce a counter-cyclical element to bank capital requirements so that adequate capital is held for both good and bad times. Inadequate capital requirements allowed banks to significantly increase leverage and credit exposures in the years leading up to the crisis, the FSA believes.
The FRO also states liquidity regulation needs to be reviewed to incorporate more effective supervisory processes, reporting requirements and risk management. On December 4, 2008, the regulator published a consultation paper, CP 08/22, which recommends that firms pay greater attention to the assessment and management of liquidity risk. The paper proposes that banks hold a "liquid assets buffer" of short-term government bonds to mitigate liquidity risk.
"Meeting these new requirements will mean significant improvements in some firms' internal analytical and liquidity risk management approaches will need to be made," the FSA said yesterday.
The Turner Review will also include analysis of credit rating agencies, fair value accounting and the arrangements for clearing of credit-default swaps. It is scheduled to be published by the end of March.See also: Trading book capital must be "several times" higher, FSA says
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