Capital Adequacy regime

The Turner report identifies the need to adjust the present capital adequacy requirements introduced under Basel II.  The return to an old fashioned principle of saving up for bad times ahead will introduce a counter-cyclical measure to the current regime aimed at reducing the probability of another banking crisis. New importance will be given to supervising capital adequacy using an approach which enables the banks to better understand their risk position in good and bad economic times.

Transformation will not end with new counter-cyclical measures. It will also involve increasing the level of capital banks should maintain in order to account for market shifts to accurately reflect the level of risk held on trading books.

The old way of regulating has failed in this present crisis to take into account the low (but real) probability of catastrophic events that can and have occurred and further changes will be required in the techniques used to analyse how much capital needs to be held, particularly the Value at Risk (VaR) methodology.

As we move forward, trading activity and potential losses on the trading book will come much more sharply into focus. As liquidity in OTC markets has disappeared in what once were liquid but are now regarded as 'toxic' assets, the strength or risks of a bank's trading book will supervised more as a key indicator of the strength of the bank as a whole. Along with capital adequacy, limiting the liquidity risks which banks face and ensuring a better understanding of market-wide liquidity risks is set to become a key area of focus for the FSA in the future.