Bank of England leaps on Leverage Controls

George Osborne has surprised markets with his second U-turn in as many days. In a published exchange of letters with the Governor of the Bank of England, the Chancellor asked the Bank to begin an immediate review as to “whether and when” it required formal powers to mandate leverage ratios for banks. Mr Osborne had previously ruled out even asking the question until 2018, just prior to the phased-in imposition of Basle III capital controls. The letters reveal a distinct difference in emphasis between the Treasury and the Bank. The Chancellor strikes a cautious note, asking for “clear evidence” that a more stringent leverage regime would result in stability and “would wish to understand” the implications for the wider economy. Mr Carney welcomes the opportunity of a review, but seems to regard its conclusion as obvious, convinced that Canada, his previous financial fiefdom, benefitted greatly from leverage restraint. Mr Carney re-iterated his bullish and interestingly independent, stance in front of the Treasury Select Committee – “My personal view is that we should have these powers”. While the Bank already has de facto control over the leverage ratio of individual banks, its regulatory arsenal lacks an explicit “power of direction” over the sector as a whole. The review will take 12 months and it seems overwhelmingly likely that the BoE, in its guise as the FPC, will decide that this important new power is necessary in its guise as the FCA. Mr Carney said he expected the new power to be in place by early 2015. This represents a significant advance on the Basle III \ CRD IV timetable, and if the BoE were to follow the US precedent which has instituted a stricter leverage diet than mandated by the Basel III accord, the UK banking sector (possibly excluding Scotland) may be climbing a new cost of capital cliff a lot sooner than anticipated.