Sir John Vickers, one of the UK's most respected economists, has used an Imperial talk to criticise Bank of England policy on capital requirements.

Professor Vickers delivered a lecture on ‘The systemic risk buffer for UK banks’ at the Brevan Howard Centre for Financial Analysis at Imperial College Business School on Wednesday evening. 

Professor Vickers, who chaired the UK government’s Independent Commission on Banking in the wake of the 2007-08 financial crisis, has made a series of recommendations to improve stability and competition in UK banking.

One of those key recommendations, that banks ring-fence extra capital equivalent to at least 3% of risk-weighted assets has not been adopted by the Bank of England which believes that 1.3% is sufficient. 

Systemic risk buffers are portions of a bank’s capital that are held separately from their other operations in case of a financial shock. They are intended to help banks to continue lending even in times of stress, maintaining stability in the financial system. 

This issue is especially important in the wake of the 2007-08 crisis, “the cost of which we are all still feeling big time”. 

Sir John actually wanted to recommend a higher level but was “boxed in by constraints” like geographic arbitrage – the differing costs of doing business by region – in a globally facing UK banking system.

He was “surprised” at how low the Bank of England’s requirements on systemic risk buffers were set. 

'Baffling' assumptions

After Sir John made his displeasure with the Bank’s policy clear in a Financial Times op-ed and BBC Today interview earlier this year, the Bank responded. He said last night that “the vigour of the response from the Bank of England was surprisingly strong – it was quite flattering really”. 

Mark Carney speaking at the Brevan Howard Centre in 2015

Bank of England Governor Mark Carney has said that “bank capital is not costless to society” in response to Sir John’s analysis. The Governor claims that “if capital requirements are increased, some of those costs will be passed on to households and businesses in the real economy.” 

During his lecture for the Brevan Howard Centre, Sir John rebutted the Governor’s assertion, explaining that while ring-fencing extra equity is costly to banks, it does not have a societal cost. 

In fact, Sir John said, “more equity is free insurance” for the financial system and taxpayers – who may have to bail out failed banks – and “risky banks need more equity, not less”.

Sir John Vickers

He also criticised some of the “baffling” assumptions behind the Bank of England’s calculations for optimal capital buffer levels. “One would not base flood defence policy on a cost-benefit analysis of improving flood defences in normal weather conditions,” he said. 

Sir John emphasised the disparity between academic economists – including Imperial’s Franklin Allen and David Miles – among whom there is a “consensus” that the capital buffer should be significantly higher, and policymakers like those in the Bank of England. He said “this is a strange area of public policy” where there is “a disconnect between the policy and academic community – it’s a puzzle”.

The Brevan Howard Centre was launched in 2014 with the intention of acting as a bridge where such gaps between academics and policymakers occur.