LONDON (Reuters) - A few simple rules should form the backbone of bank regulation after the financial crisis and one should be a leverage ratio to curb banks’ ability to over-stretch balance sheets, former U.S. Federal Reserve Chairman Paul Volcker said on Wednesday.
Volcker, asked to bring an international perspective to a UK inquiry on bank reforms, said: “I really would say strongly that the risk-based capital standard ought to be supplemented by a leverage ratio.”
A leverage ratio is a simple measure of a bank’s assets to capital and is regarded as a blunt tool that caps the assets a bank can hold. If a leverage ratio were set at 3 percent, for example, it would mean a bank could leverage up to 33 times its equity.
It contrasts with more complex capital ratios used to gauge a bank’s health, where banks can adjust risk weightings they apply to assets.
Volcker, 85, Fed chairman from 1979 to 1987 under Presidents Jimmy Carter and Ronald Reagan, has been involved in drafting new U.S. financial regulations, due for completion by the end of the year, including the “Volcker rule” which aims to ban banks from taking risky bets for their own gain.
Britain plans to go further and force banks to separate basic retail banking savings and lending services and “ring-fence” them from risky investment and trading activities.
Volcker told the Parliamentary Commission on Banking Standards the UK’s plans to force banks to separate domestic retail banking services from risky investments was a welcome approach but would be hard to achieve.
Separating the two types of banking would be “effective to a considerable extent” in allowing risky parts of banks to fail without damaging the main business, but putting the theory into practice was not easy.
“Based on the American experience, the concept that different subsidiaries of a single commercial banking organization can maintain total independence either in practice or in public perception is difficult to sustain,” Volcker said.
He said there were holes in such a system that “are likely to get bigger over time”. He added: “I don’t know what it means to have an independent board that is a subsidiary of another board.”
Britain’s banking inquiry was set up after a series of scandals, including the manipulation of Libor interest rates by Barclays Plc (BARC.L) and the misspelling of insurance policies to millions of customers by all big banks.
The Libor scandal was “an example of the problem in culture in banks”, Volcker said after the session.
Volcker, educated at the London School of Economics in the early 1950s as well as Princeton and Harvard Universities, said the culture of banking had “changed radically”. That was related to too much emphasis on trading activity, complex financial engineering and the related spread of “aggressive compensation practices.”
He said there were four areas of “unfinished reform,” involving money market mutual funds; the potential usefulness of debt instruments that can convert into equity; credit rating agencies; and common accounting standards.
The UK inquiry is expected to call bank executives and other regulators and make legislative proposals by December 18. Two of the authors of reports on structural change for UK and European banks, Erkki Liikanen and Martin Taylor, will appear at the inquiry later this month.
Reporting by Steve Slater, Sarah White and Dasha Afanasieva; Editing by Robin Pomeroy and Jane Merriman