Arbitrage threat kept 'fallible' leverage ratio to 4%, says Vickers

Vickers says his 'blue skies thinking' leverage ratio would have been 10%, and adds stress testing avoids banks gaming the system
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John Vickers, chairman of the UK's Independent Commission on Banking, today told a panel discussion at the IMF in Washington, DC, that the potential for geographical and bank-to-non-bank arbitrage kept him from recommending a leverage ratio for banks of 10%.

He said his commission was "constrained" by three considerations when coming up with the leverage ratio of 4%, which they ultimately recommended: geographical arbitrage; arbitrage of banks to non-banks; and the distance from "where we are to where we want to get to".

However, he cautioned: "When you consider how the world diverges from [the ideal], you start to think of more reasons why we need more capital."

Another panellist, leading French academic Jean Tirole, said he saw the leverage ratio as "a step backward in a sense", given that there is no such thing as an optimal capital adequacy ratio. He said regulators should be "very humble"; all they know, he said, is that ratios were "recently way too low". On the other hand, however, "Lots of banks which failed were well capitalised."

Vickers agreed that "risk weights are not infallible". "Whenever you have a system of risk-weighted assets there's going to be some arbitrage," he said, comparing it to "a sort of Goodhart's Law". He said one of the benefits of stress-tests "is that you have a second-mover advantage", in the sense that banks do not have a target to aim for, to "game the system".

Whenever you have a system of risk-weighted assets there's going to be some arbitrage
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