So what will be the next Solvency II?
The regulatory requirements for insurance companies have become an improbable flashpoint between politicians searching for the benefits of post-Brexit regulatory freedom and City watchdogs prioritising the protection of customers and the financial system.
It seems questionable that a particular calculation underpinning insurers’ matching adjustment in their capital requirements is the key to unlocking brighter times for growth-starved, sewage-stained, energy-impoverished Britain.
Yet it has taken on a perverse significance: for politicians condemning cautious, “dog in the manger” regulators, for the industry sensing an opportunity to steer the conversation in their favour and for regulators, who rightly see a situation that could make their jobs impossible.
What comes next? There is, say regulatory experts, one topic looming with potential to cause a schism between Westminster and Threadneedle Street.
The Bank of England is set to launch a consultation before the end of the year about the final Basel package of banking reforms, developed following the financial crisis. Known as Basel 3.1, these were delayed by the pandemic and will make important changes to how banks calculate their risk-weighted assets, the denominator in their capital ratio. Implementation is slated for January 2025.
This is a big deal, involving changing the way capital requirements are calculated on several trillion pounds worth of assets. UK Finance, the banks’ trade body, lists 10 concerns it has regarding the design of Basel 3.1.
The basic aim is to stop the downward drift and reduce the variation in risk weights that larger banks put on assets using their own internal models. This can give big banks an advantage over smaller rivals using the regulator-prescribed standardised approach. Basel 3.1, as agreed internationally, proposes an “output floor” that means banks must take the higher of their own models’ output or about three-quarters of the standardised number.
No one yet knows how faithfully the Bank will stick to the international version, or the implications of that for the UK sector. But there are several bones of contention here. Banks may chaff at the watering down of their autonomy to use their own data and models to risk assess their assets. There are questions over whether the flexibility on offer for lending to infrastructure projects or small businesses is sufficient. There are particular worries about a chilling effect on lending to companies without a credit rating, where capital requirements could become punitive. The sector is, as ever, fretting about regulatory gold-plating.
The potential for direct political interference here is more limited than with Solvency II (the idea of a government call-in power aside). The regulator was given broad discretion to implement Basel 3.1 in the UK in legislation passed last year. However, that came with “enhanced accountability” that required it to consider both the impact on financing of economic activity and the UK’s standing compared to other financial services centres.
The trouble is that Europe, where changes proposed by the Commission are being debated, looks set to diverge markedly from the international standards — in terms of how the output floor would function, the latitude on offer in certain areas and by giving banks longer to make changes. It is a short hop, skip and a jump to a conversation about UK institutions losing out to European rivals, or the regulator cutting off funding to hard-pressed SMEs.
There are good reasons to think that this shouldn’t blow up politically in quite the same way. The issue doesn’t have the easy, political resonance of the insurers’ pledges to invest billions into green infrastructure and affordable housing.
Regulators and the Treasury have — to date — both been committed to adhering to Basel standards, and the idea that that in itself is a boon to London’s position as a place for international banks to do business. Parts of the industry even agree. Memories, surely, aren’t short enough to get much backing for the notion that there are quick economic wins in backsliding on bank capital.
Still, no one really expected the enduring mysteries of insurance regulation to become a political hot potato either.
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