by The FT reports that due to “modest but rising credit growth”, the Bank of England’s Financial Policy Committee (FPC) considered raising banks’ countercyclical capital buffer. According to the FT's Caroline Bingham: This measure requires lenders to build up capital in good times to draw down in more challenging times. And she goes on to say this: The prospect of yet more capital that banks must set aside would come on top of capital rules on a European and global basis that lenders must implement. They complain that these ever-increasing buffers weigh on their profits and therefore lending ability. No, Caroline, no. Banks do not "build up" or “set aside” capital. Capital is an integral part of the balance sheet structure. As the Bank of England explains, it is a form of funding: It can be misleading to think of capital as ‘held’ or ‘set aside’ by banks; capital is not an asset. Rather, it is a form of funding — one that can absorb losses that could otherwise threaten a bank’s solvency. And you really shouldn't listen to the complaints of banks. They talk their books. Like any corporation, a bank’s balance sheet is made up of assets, which are principally but not exclusively loans, and liabilities (debt), which are principally but not exclusively deposits. The equity of the bank (shareholders’ capital) is the difference between assets and liabilities.
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Frances Coppola considers the following as important: banks, Capital, Financial Crisis, financial stability, liquidity, regulators
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This measure requires lenders to build up capital in good times to draw down in more challenging times.
The prospect of yet more capital that banks must set aside would come on top of capital rules on a European and global basis that lenders must implement. They complain that these ever-increasing buffers weigh on their profits and therefore lending ability.
And you really shouldn't listen to the complaints of banks. They talk their books.It can be misleading to think of capital as ‘held’ or ‘set aside’ by banks; capital is not an asset. Rather, it is a form of funding — one that can absorb losses that could otherwise threaten a bank’s solvency.
Tier1 capital is split into two parts. The largest portion is "Common Equity Tier1", which as the name suggests is entirely equity. The smaller portion, "Additional Tier1", may include perpetual preferred stock.
In the event of the bank suffering losses due to bad loans, it is Tier1 capital that is wiped out first. Shareholders of the bank always lose their money before anyone else. If the bank’s losses are so severe that Tier1 capital is entirely wiped, Tier2 capital is next in line.
The objective of the LCR is to promote the short-term resilience of the liquidity risk profile of banks. It does this by ensuring that banks have an adequate stock of unencumbered high-quality liquid assets (HQLA) that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario. The LCR will improve the banking sector’s ability to absorb shocks arising from financial and economic stress, whatever the source, thus reducing the risk of spillover from the financial sector to the real economy.
As the name indicates, the purpose of this buffer is to counteract the effects of the economic cycle on banks’ lending activity, thus making the supply of credit less volatile and possibly even reduce the probability of credit bubbles or crunches. It works as follows: in good times, i.e. where an economy is booming and credit growth is strong, it requires a bank to have an additional amount of CET1 capital. This prevents that credit becomes too cheap (there is a cost to the capital that a bank must have) and that banks lend too much.When the economic cycle turns, and economic activity slows down or even contracts, this buffer can be “released” (i.e. the bank is no longer required to have the additional capital). This allows the bank to keep lending to the real economy or at least reduce its lending by less than would otherwise be the case.
This, of course, explains why banks complain about the CCB. After all, raising their cost of funding by forcing them to use equity instead of debt hurts their profits, poor darlings, and makes them less willing to lend. That, Caroline, is its purpose.
Related reading:
The equivalence of debt and equity
Anatomy of a bank run
Cleaning up the mess
Liquidity matters
Bank capital and liquidity - Bank of England
CRD IV: Frequently asked questions - European Commission
The Bankers' New Clothes - Admati & Hellwig (book)
I've expanded the section on Tier1 and Tier2 capital slightly after complaints from some readers that it was over-simplified in the original version of this post. However, I've still kept it simple and have deliberately not gone into detail about the additional capital layers in CRD IV, of which the CCB is one. For a more detailed explanation of CRD IV regulatory capital structure, please read the European Commission's Q&A in the links above.