The new financial risk watchdog is calling for sweeping powers to bring banks to heel and avoid having to dig into taxpayers pockets again in the next crisis, a top Bank of England official said on Friday.
As part of a root-and-branch reform of supervision, the Financial Policy Committee (FPC), launched on an interim basis this year, will direct regulators to take specific actions.
Andrew Haldane, the Bank of England's executive director for financial stability and an FPC member, wants the committee to have a wide range of tools to change the behaviour of banks, markets and consumers.
"I hope in time the FPC policy actions will be sufficiently understood, that the signal itself is enough to engineer a change in tack by banks lending and borrowers borrowing," Haldane said in an interview at the Bank of England.
In the interview, Haldane also discussed markets' risk aversion and bank profitability.
The FPC will use its tools to help smooth out the peaks and troughs of the banking cycle. The government decides early next year on the range of tools it will be able to use from the start of 2013.
It has already been agreed the FPC will be able to change the overall level of capital held by banks and fix a new "countercyclical" bank buffer to curb lending.
"This is a powerful new bit of kit, wholly new to the regulatory apparatus," Haldane said.
"There is a strong case for augmenting that aggregate instrument with some rather more specific, possibly sectoral ones. We have spoken about the importance of perhaps adjusting risk weights," Haldane said.
The FPC could then order banks to increase capital buffers according to their exposure to a sector that was overheating, for example commercial property.
"Having that power we think is particularly important. I think you would want arguably a liquidity tool which could be as, and even more effective, than a capital tool," Haldane said.
Another tool would be the ability to require banks to increase -- or shrink in risk averse times -- their margins or "haircuts" in bank-to-bank sectors like secured lending.Fortunately Mr. Haldane is only throwing out an idea. It is the responsibility of each bank to determine for itself the haircut it thinks is appropriate for secured lending. There are many factors that influence this haircut, not the least of which is whether the bank can tell if the borrower is solvent or not.
The FPC may want the power to impose loan-to-value (LTV) ratios, telling consumers how much of a deposit they must raise to buy a home when the housing market is frothy.
But given the political ramifications of this -- and the need to balance its effectiveness -- Haldane said this tool will remain on the FPC's "long list" for now.
Banks want regulators to slow down tougher bank capital and liquidity rules known as Basel III, arguing this will allow them to keep lending to businesses.
Haldane said Basel III has a deliberately long phase-in to 2019, allowing it to ride through a worsening economy.
"So I think on most plausible projections, say on bank capital ratios, there is still an eminently feasible transition path between where we are now and Basel III, well ahead of 2019," Haldane said.
Britain has forced banks to hold more capital and liquidity than required under global rules but Haldane said they are being allowed to tap these buffers to absorb current stresses.
Some of the "fog" around risk weights used by banks to calculate capital buffers needed lifting, Haldane said.
"We should think about ... whether you would want to impose some floors on the risk weights that might attach to particular assets to ensure those risk weights aren't gamed away by complex modelling within banks," Haldane said.
"I think that would be good for banks, good for regulators, I think it would be good for markets if there was a degree of assurance that there was no jiggery-pokery with risk weights and models," Haldane said.Ultra transparency takes care of this problem as market participants will independently calculate each bank's capital ratio. This eliminates any games being played by banks with their internal models and puts all banks on the same basis.