Bank capital rules coming into force this month are too complex and efforts to simplify them are already underway, a senior Bank of England official said on Monday.
Andrew Haldane, the bank's director of financial stability, was among the first senior regulator to question Basel III, the world's core regulatory response to the 2007-09 crisis, that led to banks being bailed out by taxpayers.
Basel III, agreed by world leaders, forces lenders to hold more capital, but Haldane says it is too complex and relies on banks using their own models to determine capital buffers.
He told British lawmakers there was an increasing awareness among international regulators they may have taken a "false turn in the road" by backing Basel III which was written by the Basel Committee.
"Regulators cannot really police this complex beast," Haldane said. "There are moves afoot with the Basel Committee to seek ways to simplify and streamline the move to a proper regulatory rather than self-regulatory edifice. That may take some time."
His comments signaled how Britain, whose taxpayers had to save banks including Lloyds Banking Group Plc and Royal Bank of Scotland Plc , has become a hardliner in regulation after years of "light touch" supervision before the crisis.
The Basel Committee said earlier this month work on reviewing in-house models would be accelerated this year.
"There is a big straw in the wind ... The big trend here is the retreat is from in-house models," said Simon Gleeson, a financial lawyer at Clifford Chance.
The lawmakers sit on a commission that is due to propose legislative changes, perhaps by March, to improve standards in banking.
But Haldane said Britain won't wait for Basel's work to finish and the Financial Services Authority watchdog was already forcing banks to use simpler models for totting up risks from commercial property on their books.
"There is no reason why they could not do that across a wider set of portfolios," Haldane said.
There was also nothing to prevent UK regulators from imposing "floors" below which capital levels could not fall irrespective of what internal models show, Haldane added.
He is member of the bank's Financial Policy Committee (FPC), which sets the tone and direction for regulation in Britain. From April, the bank becomes the regulator for lenders.
There was also support on the FPC for a higher leverage ratio or balance-sheet cap on banks than the 3 percent set under Basel III, he said.
Haldane hoped Britain could also persuade its European Union partners to tighten an EU code which governs how much of a banker's bonus is paid upfront in cash.
Again, Britain could take unilateral action.
"My understanding is there is room to be more prescriptive," he said.
Accounting rules used in the EU, drawn up by the International Accounting Standards Board, were also "not as prudent as they could and should be for financial firms," he said, arguing the rules failed to ensure banks make early provisions on souring loans and also lead to under-recognition of losses.
Reforms to accounting rules put forward by the IASB and its U.S. counterpart were still "unfinished business" and therefore Britain was asking banks directly to make bigger provisions than they need to under accounting rules.
"We are working privately with FSA and auditing firms to see if we can't at least provide better disclosure about fair value gains and losses than is the case right now," Haldane said.
The UK authorities are thrashing out a "prudent valuation framework" to put a price tag on illiquid or toxic assets, and force banks to make deductions from their capital buffers.
"We might in time be able to inject a notion of prudent valuation into accounting," he added.
(Editing by David Holmes)