Sam’s Basel Bufferati

Sam Woods’ latest speech “Bufferati” given at City Week on April 26^th is a real corker – and its full of dreadful jokes too.

As his colleagues were finishing of their magnus opus Basel III – a hideous monstrosity that should have been killed at birth – Sam wonders out loud about an alternative, which he calls the Bufferati model. Think of capital standards as car models, he suggests. He continues

But I have found myself thinking it might be a good idea to introduce, on the next door assembly line as it were, a new concept car version of the capital stack – radically simpler, radically usable, and a million miles away from the current debate but which might prove instructive over the longer term.

It is refreshing to see a regulator of Sam’s seniority thinking in first principles’ terms. He goes on to say

Design features

While the capital regime is fiendishly complex, its underlying economic goals are fairly simple: ensure that the banking sector has enough capital to absorb losses, preserve financial stability and support the economy through stresses. In developing the Bufferati, my guiding principle has been: any element of the framework that isn’t actually necessary to achieve those underlying goals should be removed. The Bufferati is as simple as possible, but no simpler.

With that mind, my simple framework revolves around a single, releasable buffer of common equity, sitting above a low minimum requirement. This would be radically different from the current regime: no Pillar 2 buffers; no CCoBs, CCyBs, O-SII buffer and G-SiB buffers; no more AT1. [His emphasis]

A little later he adds

“At the core of this concept is a single capital buffer, calibrated to reflect both microprudential and macroprudential risks and replacing the entirety of the current set of buffers. [Our emphasis]

And a nice summary

So in summary, the Bufferati has:

1. A single capital buffer, calibrated to reflect both microprudential and macroprudential risks.

2. A low minimum capital requirement, to maximise the size of the buffer.

3. A ‘ladder of intervention’ based on judgement for firms who enter their buffer – no mechanical triggers and thresholds.

4. The entire buffer potentially releasable in a stress.

5. All requirements met with common equity.

6. A mix of risk-weighted and leverage-based requirements.

7. Stress testing at the centre of how we set capital levels.

There is some good stuff in there, but it’s still a bit of a dog’s dinner, leaving a lot of scope for regulatory discretion, gaming of metrics and most worrying of all, the adjective ‘low’ as in ‘low capital requirements’ is a massive red flag.

But in the spirit of Sam’s bufferati/buggerati/whatever model, we would like to suggest some slight improvements as follows, in bold:

So in summary, our improved Bufferati has:

1. A single capital buffer, calibrated to reflect both microprudential and macroprudential risks.

2. A high minimum capital requirement, with the minimum ratio of capital to leverage exposure or total assets set at (at least) 15%.

3. No ‘ladder of intervention’; only mechanical triggers and thresholds.

4. All requirements met with market value common equity.

5. Only leverage-based requirements.

6. No stress testing.

So just a couple of tweaks there, Sam, and you’re fine.