Global regulators should consider forcing banks to hold a fixed amount of capital to cover assets on their books because relying only on banks' own calculations is not safe, Bank of England deputy governor Paul Tucker said on Wednesday.
In a speech at the British Bankers' Associations annual meeting, the front-runner in the race to be the next central bank governor laid out the broad regulation agenda for the banking system.
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He questioned how banks are allowed to calculate their own capital reserves by assessing how risky their assets are.
"Leaving banks completely free to choose risk-weights, using internal models, is not safe," Tucker said.
"It effectively allows banks to determine their own regulatory capital requirements, which hardly fits with society's purpose in regulating banking in the first place."
He said the introduction of mandated floors on risk-weights should be debated in the global Basel Committee on Banking Supervision, meaning banks would have to hold a basic amount of capital as a backstop whatever the level of riskiness.
He is the latest policymaker to cast doubt on the effectiveness of new global bank rules known as Basel III, even though they have yet to be introduced formally.
Basel III, written by the Basel Committee, rely heavily on banks' internal models for calculating their own capital buffers.
Tucker stressed that allowing banks to fail and exposing bank debt holders to losses is a key element of the regulatory changes.
Britain's plans to ringfence retail banking from riskier investment operations were a central element to making banks resolvable. "The proposals in the recent Liikanen Report on the structure of EU banks are welcome in seeking to achieve the same goal," he said.
Tucker also suggested that bank management should be more exposed to the risks of bank failure by paying managers to a "significant extent in subordinate debt".
Tucker also highlighted the importance of the Bank of England's new macroprudential approach, which aims at spotting and reducing system-wide risks.
(Reporting by Sven Egenter and Huw Jones; editing by Patrick Graham)