Crisis will shape regulatory capital, says UK FSA chairman

Market events will affect future capital requirements, according to the new FSA chairman, challenging Basel II on liquidity risk and pro-cyclicality

WASHINGTON, DC – The chairman of the UK’s Financial Services Authority (FSA), Lord Adair Turner, says regulators will move to raise banks’ core capital and prevent pro-cyclicality amid a constantly shifting and uncertain environment. Speaking at an international banking seminar in Washington, DC, Turner, only three weeks into his new job, said it had been “like getting on board a roller-coaster”.

Turner’s remarks indicate the growing threat to Basel II and its European Union legislative vehicle, the Capital Requirements Directive (CRD). New capital increases for risky structured products, rules on banks’ funding sources and rating agency regulations have already combined to significantly amend the directive.

Turner said: “Regulatory regimes will, I am sure, demand more capital in financial intermediation, both through higher capital requirements for banks and more effective steps to prevent highly leveraged shadow banking entities escaping capital regimes.”

He went on to question two further areas of Basel II that have been the subject of criticism since the onset of the current market turmoil: liquidity risk, on which the new capital regime has been considered lacking, and pro-cyclicality, market behaviour it is accused of encouraging.

“First, how can we remove the dangers of pro-cyclicality in capital adequacy regimes (which we should undoubtedly aim to do) and should we go further and have overtly anti-cyclical regimes, such as Spain’s dynamic provisioning approach?” said Turner.

He ended by confirming that, in every major developed economy’s banking systems, there will be significant de-leveraging and reductions in the total size of the financial sector’s balance sheet. The process of that de-leveraging, he said, will raise some complex economic management issues as well the reversal of the march of securitisation.

Click here to read the speech in full: http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2008/1013_at.shtml