Banks ‘aren’t safe enough yet’, says Professor John Vickers

Shareholders’ equity should be three times higher than it is, according to the former chief economist of Bank of England.

Professor John Vickers, former chief economist at the Bank of England.

A key architect of Britain’s post-crisis banking reforms, Professor John Vickers, has blasted regulators’ approach to minimum bank capital levels as “simply wrong”, suggesting so-called “bail-enable” debt is untested and shareholders’ equity should be about three times higher than it is.

Prof Vickers, a former chief economist at the Bank of England, said banking regulators around the world had made assumptions that were “wrong by a wide margin”, such as setting minimum equity levels based on normal economic conditions.

“Capital safeguards are for abnormal conditions, just as flood defences are built for abnormal weather conditions,” he said.

New banking rules agreed in the wake of the crisis, known as “Basel III”, mandate that banks’ assets be backed by at least 3 per cent equity.

Prof Vickers chaired the British government’s 2011 independent Commission on Banking, which criticised Basel and recommended higher equity levels for banks and the “ring-fencing” of investment banking from deposit taking.

“The politics of regulatory reform has resulted in a settlement that falls short of what the economics require.

‘‘We are safer 10 years on, but not as safe as we could and should be,” he said in Abu Dhabi yesterday.

Prof Vickers, now the warden of All Souls College, Oxford, said banks were safer than a decade ago but fell far short of maintaining the optimal levels of equity that experts and economists working outside the banking sector had recommended.

“A gulf this wide between official opinion and academic opinion on a truly fundamental economic policy question is extraordinary,” he said. “There is an astonishing gap … they cannot both be right,” he added.

Major bank common equity tier one ratio

A group of renowned economists, both left and right politically, including Nobel Prize winners William Sharpe and Eugene Fama, wrote a letter in the Financial Times in 2010 arguing shareholders’ funds as a share of total assets should be at least 15 per cent to reduce the likelihood of financial crises and the chance taxpayers would need to bail banks out.

“These figures are enormously greater than the Basel III settlement,” Prof Vickers said.

Higher levels of equity also put pressure on bank costs and bonuses, making it harder for banks to achieve high rates of return on equity.

Mervyn King, the former Bank of England governor, recently said 10 per cent equity would be “good start”.

The big four Australian banks’ equity levels as a share of their assets have risen from around 4.5 per cent to 5.5 per cent since the financial crisis.

Prof Vickers lambasted regulators’ use of so-called Tier 2 equity.

“That might be more tax efficient for banks, but that should not be a concern of prudential regulators acting in the public interest,” he said.

APRA recently released a plan to increase big banks’ minimum capital ratios by 4 or 5 percentage points by 2023 with recourse only to Tier 2 capital instruments.

“Will it work? Nobody knows. It’s not a sure-loss absorber”, Prof Vickers said of such instruments.

Debate about bank prudential standards has raged in the UK, among the countries worst hit in the financial crisis.

Prof Vickers also called on countries like Australia to more structurally separate investment banking activity from deposit taking, following similar moves in the UK.

“It is disappointing that structural separation measures have been rather limited internationally, despite the attempt made in the EU by the expert group chaired by Erkii Liikanen,” he said, referring to the former governor of the Bank of Finland.

He also said bank share prices related to banks’ book value have proved a better indicators of bank health than regulators’ measures based on risk-weighted assets, which were hopeless indicators of stress in the lead-up to 2008.