Draft Bank of England Act 1998 (Macro-Prudential Measures) (Amendment) Order 2021

Pat McFadden Excerpts

Tuesday 6th July 2021 General Committees

[Mr Pat McFadden (Wolverhampton South East) (Lab)]

It is a pleasure to serve under your chairmanship, Mr Efford.

The regulations will potentially do two things. The first is to square the FPC’s powers with the changes made to the PRA’s powers in the Financial Services Act 2021, which the Minister and I spent many a happy hour debating—I think it was in this Room—about six months ago. That Act gave the PRA new powers, as a result of our departure from the EU, in relation to various macro-prudential measures, specifically the capital requirements regulation. The order gives the FPC the power to direct the PRA on matters relating to holding companies.

I have three questions for the Minister about the order. First, paragraph 8.1 of the explanatory memorandum states that

“This instrument does not relate to withdrawal from the European Union”,

but did the new powers given to the PRA, which the order relates to, not result from the onshoring of the EU capital requirements regulation? If what we are doing is squaring one set of regulations with something in the 2021 Act that arose from withdrawal, does that not also relate to our ongoing and seemingly never-ending process of onshoring EU regulation? That is my first question: is this part of the onshoring process or not?

The second thing the regulations do is to make changes in relation to the total exposure measure, or the overall leverage ratio, of financial companies. That is important, because it acts as what could be called a “backstop” over and above the various risk-weighted activities that are dealt with in the Basel rules. Of course, leverage, or the lack of overall capital, were at the heart of the financial crisis. Since then, the rules have been changed to make financial companies more resilient, decreasing the likelihood of the taxpayer being on the hook and having to bail out systemically important firms in the event of a future crisis. I want to ask the Minister about that overall leverage ratio. What difference will the SI make to the way that the overall leverage ratio will be dealt with? What is the effect of excluding the balances held by the Bank of England? Will that actually make any difference to the amount of capital that a bank is expected to hold in relation to its overall loan book?

My third and final question is more fundamental. Is the Government’s policy intention that financial institutions should be required to hold less capital now that we are outside the EU than if we had remained inside?

[John Glen]

As ever, I thank the right hon. Gentleman for his questions. He referenced the leverage framework, on which I will go into some detail in answering his second and third questions.

It is the Government’s view that this instrument is necessary to ensure that the existing macro-prudential tools that the FPC has continue to operate effectively in the light of the changes that we have made in that wider prudential regime. In so far as all those changes are consequential of decisions made five years ago, I suppose that there is a tangential link, but it is not a direct causal relationship.

The right hon. Gentleman also asked about the leverage framework. It may be helpful to the Committee if I set out that that leverage ratio is an indicator of a firm’s solvency relating to its capital resources and assets and, unlike the risk-weighted capital framework, a leverage ratio does not seek to estimate the relative riskiness of assets. The purpose of the leverage ratio requirement, alongside risk-weighted capital requirements, is to guard against the danger that the firm’s models or regulatory requirements fail to reflect the current riskiness of its assets. Currently, the leverage ratio framework requires that major banks and building societies satisfy a minimum tier 1 leverage ratio of 3.25% on a measure of exposures that excludes central bank reserves, along with various buffers that relate to those in the risk-weighted capital framework. Separately, the PRA also maintains a supervisory expectation that all firms maintain a minimum leverage ratio.

The FPC and PRA have undertaken a review of the UK leverage ratio framework in the light of the finalised international standards. The Bank published a consultation on the outcome of that review on 29 June and there are three main proposals incorporated in the FPC’s consultation.

The first is the level. The proposal is to keep the existing leverage ratio framework broadly unchanged for UK consolidated groups of major UK banks, apart from implementing the Basel 3.1 changes.

The second is around scope—to extend the framework to UK banks, building societies, investment firms with significant non-UK assets and, where relevant, certain holding companies, which reflects the importance that such firms have for the functioning of the UK financial market and that the Basel standards require the leverage ratio to be applied to internationally active banks. The PRA propose to extend the leverage ratio of firms with non-UK assets of at least £10 billion, which will capture the larger, non-ringfenced banks and international broker dealers, including Goldman Sachs, JP Morgan and Morgan Stanley.

The third element is the level of the application—the leverage ratio framework would generally be extended at the individual level, except where a relevant firm is subject to a requirement on the basis of its consolidated situation. The PRA would also have discretion to allow a sub-consolidated requirement, rather than an individual one, to be applied in certain circumstances.

The Bank believes that the extension of the leverage ratio framework to internationally active firms would only result in modest additional costs for firms, which reflects that, for many firms, their risk-weighted capital requirements remain more binding than their leverage ratio requirements, firms typically hold management buffers above their capital requirements or they are part of wider groups.

In addition, the PRA has proposed other less significant changes, which reflect updated Basel standards relating to the leverage exposure measure used for calculating the ratio, and reporting and disclosure requirements, aligning with the Basel III standards to ensure that the UK remains consistent with transparency requirements in other jurisdictions.

The review of the leverage ratio framework took place in the light of those revised Basel standards. They require the leverage ratio to be applied to internationally active banks and therefore the main change being proposed to the framework moves the UK closer to international standards.

If the consultation proposals are implemented, the FPC will argue that the UK leverage ratio framework would be equivalent to Basel standards on an outcomes basis—indeed, in some areas, super-equivalent. For example, the FPC requires the leverage ratio to be met with a higher quality of capital than the Basel framework and includes some buffers that are not mandated by Basel. However, the UK framework would potentially be sub-equivalent to Basel on a line-by-line basis, as, for instance, the FPC framework does not put restrictions on distribution —for example, the paying of dividends—if a firm breaches its leverage ratio requirements. It also has a lower leverage buffer for globally systemic important banks.

There has been little reaction to these measures at the moment, but we will continue to monitor that. These are obviously complex matters that the Treasury keeps under close review. The provisions essentially ensure that we have absolute alignment of the FPC’s responsibilities and discretions to the new environment that we passed in the 2021 Act.

I hope that addresses the questions that have been raised—I am happy to give way to the right hon. Gentleman if not.

[Mr McFadden]

I thank the Minister for that explanation. Does the instrument and what it does on excluding the Bank of England balances make any difference to what he has just outlined and what the leverage ratio is? I think the answer is no.

[John Glen]

No.

[Mr McFadden]

I want to press the Minister a bit on this. Does the Government have a view on these capital requirements that is any different outside the EU from when we were in the EU?

[John Glen]

I confirm to the right hon. Gentleman that we do not. Though we are outside the capital requirements regime of the EU, our objective is to align to the highest global standards—we will just do that in a way that reflects the nuances of our banking system. We will always maintain the highest possible standards. Indeed, our international reputation relies on it.

I hope that the Committee has found my observations helpful to some degree and will be able to support the order.

Question put and agreed to.