Andrew Bailey, CEO of the Prudential Regulation Authority, gave a speech to the International Financial Services Forum on 27 January 2016 which detailed the work being conducted in the UK to prevent a repeat of the 2008 financial crash.
Mr Bailey said that by analysing the balance sheets of UK banks, it is possible to see that they increased fourfold between 2000 and 2007, and whilst that may look attractive in isolation, it does not represent a sustainable system. Current comparators to ‘pre-crisis’ figures are therefore invalid, as this period was one of instability in the financial health of the UK.
UK bank’s pre-2008 liabilities were comprised of deposit contracts, non-deposit debt (bonds) and equity contracts. As a result banks had too little equity to absorb losses, and had issued hybrid debt-equity instruments that were supposed to absorb such losses but could only do so if the bank became formally insolvent. In order to stabilise the system, in the UK there are now increased requirements for banks to hold equity capital to absorb loss and hybrid debt-equity instruments have automatic and transparent triggers that do not rely on an insolvency event occurring. In addition, regulators have introduced liquidity regulations to allow banks to withstand the loss of some funding, and requirements on banks to ring-fence qualifying EU customer deposits. In the interests of resiliency, the PRA have invested in stress-testing, and ensuring that – if banks fail – they can be resolved without recourse to public funds through the concept of ‘bail in’.
Andrew Bailey concluded that the objective of the comprehensive financial reform programme is not to return to the unstable pre-crisis years, with insufficient equity and illiquidity within the banking system, but to strengthen the loss absorbency of the system and encourage greater clarity on the bank’s liabilities. In addition, by ensuring that investors know the characteristics of the assets they hold, the UK’s financial markets will be able to deliver and prevent a “too big to fail” situation.