Tim Phillips

When you look at the world now, does it look more uncertain or less uncertain? On the 2nd of December 2025, the Financial Policy Committee of the Bank of England, the body tasked with preserving the stability of UK banks, decided to loosen the rules on one of the ways that banks manage risk. My guests today think that the committee got it wrong.

John Vickers

It’s signalling that the bank is now in a more deregulatory phase, or at least that would be the concern that I had.

Tim Phillips

Today on Vox Talks Economics, are lower bank capital requirements a capital mistake? Welcome to Vox Talks Economics from the Centre for Economic Policy Research. I’m Tim Phillips. If this sounds like your kind of episode, well, stick with us and pass it on to someone who will find it useful. Bank regulation is complicated. It’s technical, but it’s fundamental to the way that modern economies manage risk. In 2008, we found out what happens when risk builds up in the system, and after that, tighter regulation followed. A recent decision by the Bank of England has lowered the equity capital requirement for UK’s banks. These are the rules that force them to fund a minimum share of their assets with shareholders own money rather than with borrowing. And I’m speaking to two experts today who in a recent VoxEU column argued that this is a mistake. David Aikman of the National Institute of Economic and Social Research was employed at the Bank of England between 2003 and 2020 and was involved with the setting up of the Financial Policy Committee. Hello, David.

David Aikman

Hello. Great to be with you.

Tim Phillips

And John Vickers of the University of Oxford is a former Bank of England chief economist, and he also chaired the Independent Commission on Banking between 2010 and 2011. John, welcome as well.

John Vickers

Thank you, Tim.

Tim Phillips

John, what are equity capital requirements for banks? Why do regulators consider them to be so important?

John Vickers

It’s really important that financial institutions such as banks are able to absorb losses when shocks hit the system. And the one sure loss absorber that banks have is equity capital in their funding structure. So, the general idea is to make sure that there is enough of that to weather a storm, which sooner or later is bound to come. It’s expressed in quite technical ways, but that is the fundamental idea. And a big lesson of the crisis of 2008 was that was nowhere near enough of this kind of loss absorbency So banks got into massive trouble and the collateral damage to the rest of the economy and everybody in it was terrible. And we’re still suffering the scarring effects.

Tim Phillips

Financial crises through history have been regular occurrences, haven’t they? Especially when we think we’ve actually just solved the risk problems. But in recent history, the global financial crisis, this is the classic example of what happens if banks don’t hold enough capital, is it?

John Vickers

That’s exactly right. So we reached a point where well-known financial institutions had equity capital that was as low as a couple of percent, two or three percent of their exposures, the lending and other exposures that they had. So in the jargon, if it’s say two and a half percent, that means their exposures are 40 for zero times the shareholders’ capital, leverage of 40. And in that scenario, even if the accounting numbers are measuring the truth, you don’t need much of a shock to put the system into severe trouble. So the post-crisis repair job, which has had many, many elements, has been to build much better capital buffers. And the equity capital buffer is, I would say, the most important part of that repair job.

Tim Phillips

That repair job that followed the global financial crisis, regulators all over the world were involved in regulation after that. In the UK, in 2013, the Bank of England creates the Financial Policy Committee. What was that for?

David Aikman

So, as you said, it was set up in 2013. It was really a body that’s set up to be the macroprudential authority in the UK, which There’s lots of different actors involved in financial stability policy, and the FPC, the Financial Policy Committee, was really set up to be at the apex of that structure, looking at the whole financial system, banks plus non-banks, and taking that top-down perspective on whether risks were building, whether we’ve got an appropriate degree of resilience in the system, these types of questions.

Tim Phillips

And one of its actions was to set capital requirements for banks. What level did it set for them?

David Aikman

Perhaps let’s take a step back before I give you the number. And the FPC, this is in 2015, As John was describing, we’d had this build up in capital after the financial crisis. And the FPC asked the question, when would enough be enough? Can we give some clarities of banks about where we’re heading? So that was the kind of spirit of the exercise they did. And to come to an answer there, they worked with the staff to try and kind of tally up what they thought the costs of more equity would be, and what the benefits would be. We know from Economics 101 that the appropriate answer to that would then be something that equates the marginal costs and benefits. So they came out with a number back then of 14%. Now, there’s a load of technical complications there, in terms of what that number actually means, because it’s not quite referring to the pure equity capital buffer that John was referring to. Let’s leave those to one side because they are a little bit for the nerds in this space. But I think the key thing is they were trying to provide that clarity And one of the big factors that entered that calculus was a belief that resolution frameworks were going to be very, very effective and it would mean that future crises would be less costly. So, that’s allowed the FPC, in its judgement, to run with a much lower capital ratio than what their analysis would have otherwise pointed to.

John Vickers

Tim, you mentioned in your intro that I chaired the Independent Commission on Banking, and we were all for considerably higher equity capital levels and other forms of loss absorbency. And those other forms take us into the resolution question. A big decision that the FPC made end of 2015, early 2016 was, what extra buffer should the big domestic banks have? And the ICB, Independent Commission on Banking, was all for using to the full the scope the parliament had given to the FPC, which would have been a 3% in terms of risk-weighted assets. We may come on to what all that means. But they chose not to. They went very significantly lower than that. And it’s not only the very high confidence that they expressed in resolution working, i.e., banks able to absorb losses even when they’re gone concerns, but it was also, in my view, a highly optimistic view about the regulators’ ability to see risks coming and use of the so-called counter-cyclical capital buffer. And if you didn’t share that confidence, and I certainly didn’t, you would have gone for considerably higher equity levels than they did.

Tim Phillips

So that 14%, even at that time, is it fair to say that both of you were sceptical that that was an appropriate level at which to set the buffer?

David Aikman

I would certainly agree with that as well. At the same time, I would recognize that these calculations are hugely uncertain. The spirit of the exercise was to provide some clarity to banks, but I’m in the same view as John, that if it was my decision, I would have continued to build a little bit more capital than where they ended up, because they effectively locked in where banks had actually got to at that point. It’s kind of saying we’ve gone far enough And ultimately, it comes back to a view about how costly do you think crises are and how much insurance do you want to take out against a future one happening? One striking calculation is, I saw this in a parliamentary report, if you just assume that GDP would have kept growing in the UK on its pre-crisis trend, which is optimistic, but it helps put a number on this at least, the economy would have been 25% bigger now, relative to where we’ve ended up. So it gives you a kind of a crude way of thinking of how large the costs of crises are. We therefore want to be pretty sure we’re not going to get another one, I think.

John Vickers

And another curious thing about this whole debate is that it sort of assumes that higher equity is costly to the economy. But if you analyze it carefully, that’s far from clear. I’m sure if you ramped up very rapidly the capital requirements on the banks, then that would squeeze lending. But if you do it in a gradualist way, the economics of this says there might be no cost at all. So the insurance that David talks about might be an absolute freebie.

David Aikman

And an example of that is US banks are actually better capitalized than UK banks or had been until the recent deregulation and the economy there is doing pretty well. So it’s, it leads you to be a little bit skeptical about those arguments that this will kill the economy effectively.

Intermission

Our financial system is supposed to be more resilient than before the global financial crisis. But in 2023, that didn’t save Silicon Valley Bank, Signature Bank, or First Republic. So what went wrong? In our episode, Making Banking Safe, from December 2023, we spoke to Steve Cecchetti and Kim Schoenholz about how regulators… should have responded. Subscribe to listen wherever you get your podcasts.

Tim Phillips

For anyone who wanted to support the argument that 14% was enough, then they could turn to the fact that UK banks didn’t get into trouble during this time. Bringing this up to the 2nd of December last year, and a Financial Policy Committee announces a change. What is the new benchmark? They’re not recommending 14% anymore. They’re recommending something different. What is it?

David Aikman

So they’ve effectively cut the level by 1% of risk-weighted assets. So it’s now 13%. It sounds like a small change in the scheme of things. To put some numbers on that, I think that’s going to equate to something like 30 billion pounds of capital, if the banks use this opportunity to lower their capital ratios. So that’s not a trivial amount. I don’t think you should look at that policy announcement in isolation. It’s signalling that the bank is now in a more deregulatory phase, or at least that would be the concern that I have. So I think there’s other things that we can look for, other types of regulation that will also be, they’ll be looking at and considering whether to adjust downwards. So you should think about it in that bigger picture, I think.

Tim Phillips

Has the FBC been explicit in its reasoning for making this change?

John Vickers

Yes and no. They’ve put out a paper paper. explaining why they’d done it. As an outsider now to the bank, I found it quite hard to follow some of the steps. And I think what surprised David and me, we had this independent reaction that was identical. Even if you think the 2015 settlement was correct then, when you look at the world now, does it look more uncertain or less uncertain? It surely looks more uncertain, for all sorts of reasons. Inbetween, we’ve had Brexit; we’ve had the pandemic; and among other things that has made the fiscal position, which would surely take a knock if there was a financial crisis, much more stretched. So, you’d think if there was going to be a change from 2015, it would be upwards, not downwards. So, it’s a directional puzzle which struck the two of us.

Tim Phillips

All of us that lived through it can remember those astonishing days of 2008, and for the two of you being right on the inside of that. That must have been an extraordinary time in your career.

John Vickers

Well, luckily, I was on the outside. David was on the outside.

Tim Phillips

But as we get further away from it, then there is that slight amnesia that creeps in. Can we infer that political priorities – the need to say that we need to promote growth and use investment to promote growth – or can we say that also external lobbying on behalf of the financial services industry has played a part in this move from 14 to 13?

David Aikman

I would agree with the points you just made there. I think a third factor is the international context. So we’ve seen a big shift in the US for some years now towards deregulation. I think the argument is the large UK banks are operating in that globally competitive environment. They’re seeing capital requirements falling for big US banks. We’re seeing similar things in Europe as well. Alongside the domestic push for more growth, I think that’s one way to understand how we’ve found ourselves in this position. And it’s a difficult one for the Bank of England because those are real things about competitiveness, but it’s at the same time… I think we would still say it’s a mistake because the costs will be borne by the UK states and the UK economy if there is a crisis. But that context, I think, makes it especially hard.

John Vickers

And just the idea that weaker capital regulation of banks is good for growth, is for the birds! I mean, David earlier talked about the GDP hit from the last crisis. It just is not true as a general proposition that this is a good way to get growth. Moreover, what the banks are clearly keen to do is to pay out more dividends to their shareholders and to do share buybacks and all the rest. And this is on a very, very large scale. liberalisation doesn’t translate necessarily to more lending at all. It could do a very different thing in terms of payouts to shareholders. I completely understand the government’s growth priority, but it certainly shouldn’t be assumed that that points in a deregulatory direction as far as this policy goes.

Tim Phillips

Let’s have a look at how this decision is implemented in practice. Now, I understand that this move to 13% applies when Basel 3.1 is implemented. That’s not until the beginning of 2027. Is anything going to change before then? And might we reconsider before then?

David Aikman

It’s one of these things that’s a little bit hard to see from the outside. I suspect not. Actually, let’s take a little step back and just remind ourselves what this means. So this is the FPC saying the overall capital envelope, if you like, for the UK should be now 13%. And it’s really up for the individual regulators, things called the PRA, I’m afraid everything has an acronym in this world for the micropredential regulators to decide how to transmit that into their own micropredential add-ons and everything like that. I suspect, nothing will happen in this front, as you said, until the Basel 3.1 package comes through. Now, what is that? That’s an attempt by the regulators in Basel internationally to correct some of the things they’re not happy with in terms of how they’re measuring risk, this idea of risk weights. So the logic, it makes a little bit of sense. If we could get better at measuring risk, the risk-weighted asset amounts would be a little bit higher and therefore we could have slightly lower ratios relative to that bigger risk-weighted asset total. But there’s a whole load of assumptions in that about how much of an improvement in risk capture will we see through Basel 3.1, and secondly, will we actually implement the package? I mean, there’s been a whole series of delays and rollbacks to the implementation internationally. And again, I think it’s hard for the UK to do something in the current environment, or they seem to find it hard, if other big jurisdictions are not moving ahead with it. So I think there are questions about whether any of this will actually happen.

John Vickers

It’s telling, isn’t it? The crisis 2008, you just said, Basel implementation 2027. You think, hang on, that’s 19 years. The pace at which these things go, you know, the general public might think, okay, we understand you mustn’t go too fast, but this seems pretty slow. The other point, which is signalled by the Bank of England’s December statement, is attention to the so-called leverage ratio cap. So, we’ve been talking about risk-weighted assets. And risk-weighting is an art of science that is not fully understood. And a lot of the story of why we had the crisis of 2008 was that regulators were far too tolerant of banks attaching low risk weights to their exposures. And we’re now in a situation where some of our UK banks, it’s the backstop, the leverage ratio cap, which is a – we can go into technicalities – but it’s a number like 3% or 4%. That’s not applying risk weights, is the equity ratio And one view is, well, if that backstop is binding, we’d better ease it. We don’t want the backstop binding. David’s view, my view, is that’s the wrong reaction. This should more be an alarm bell ringing about whether the risk weights are continuing to do their job.

David Aikman

Yeah, I fully agree with that. And one point I’d add is the alarm bell is a very important point. Why is it that this leveraged backstop is now the binding constraint?  I think what’s happening is we’ve seen a lot more banks lending to the non-bank financial sector, and that lending is often backed with collaterol or it’s in the form of a credit line and those types of exposure tend to have very low risk weights. But we can ask ourselves is that a development that we’re happy with?  Having a greater network connection between the banks and the non-banks or is that a potential source of systemic risk? But I agree entirely with John that this leverage ratio debate will be the next thing to look out for in terms of what the regulators are doing. I think we’re both concerned that the reaction will be an easing of this backstop, which would obviously allow more leverage in the system.

Tim Phillips

I’m interested in how the banks are going to respond to this, even if the requirement goes down to 13%, because they are holding capital that is above the 14% limit at the moment. Now, naively, I maybe assume that they’re making their own risk calculations and holding a little bit more because of that. So therefore, if you move it down to 13%, they wouldn’t do anything. Am I wrong in that?

David Aikman

There is an element of truth to that. I think it’s sometimes the rating agencies that are providing the constraint there, which is kind of similar to what you’re describing. But it’s banks not wanting to bring their capital ratio below peers, and then they would suffer a rating downgrade. That sort of dynamic raises the question, shouldn’t that be the FPC’s job and the regulator’s job to make sure we’ve got the right amount of capital in the system? We shouldn’t be delegating that to rating agencies who have their own incentive issues. But you are right, there is this kind of headroom amount that the banks hold. I think in addition, it probably reflects very complicated things about capital at the individual country level versus the group level and where it can be freely allocated across the group. So I think that’s a very complex set of issues.  Probably the guts of your question is, will the banks react to this? And we might hope that they won’t, because of this rating agency pressure for the banks to maintain quite high ratios.

John Vickers

It gives them more scope for these higher dividends and share buybacks, which they’re doing very actively.

Tim Phillips

So, I know crossing your fingers isn’t a very good reaction when it comes to sort of bank regulation, but let’s try that and hope that there is a good outcome or at least not a bad outcome to this. And there’s a good scenario. What would that good scenario be? And I guess to finish off, what we have to say is, what are you worried about? What is the bad scenario that would happen if this turns out to be a capital mistake?

John Vickers

The good scenario is that we have steady and stable growth in the economy, and these buffers are never called upon. Sometimes when I’ve been teaching on this, I’ve been asked by students, well, where do you think the next crisis is going to come from? And my answer to that is, a), I don’t know, and b), that’s the whole point:  Nobody knows. So the point is to get to a resilient place so that when shocks hit, all is fine.

David Aikman

Coming back to this leverage ratio discussion, I think that’s the thing that worries me. If you weaken the backstop, what does it then mean to be a backstop if you’ll weaken it when it begins to bind? So I think we’ll learn quite a lot about how the bank is thinking through that lens. So that’s the thing I’m looking for and the thing that I’m personally worried about.

John Vickers

Don’t forget, it’s only three years ago, US regional banks, some of them, and Credit Suisse, a major global bank in Switzerland, they were in trouble, even in a relatively calm macroeconomic environment. So that should surely be a lesson, that these problems have not gone away and that we need to preserve very good resilience, not least for the sake of growth.

Tim Phillips

We don’t know when the next crisis is turning up or where it’s coming from, but unfortunately, I think we can be pretty sure that something’s going to happen sooner or later. Let’s hope it’s not because of this. Thank you very much for talking about it today. Thank you, David.

David Aikman

Pleasure. Thank you.

Tim Phillips

And thank you, John.

John Vickers

Thanks very much, Tim.

Tim Phillips

The article was called The Bank of England’s Capital Mistake. Authors David Aikman and John Vickers. It was published on VoxEU on the 15th of January, 2026. VoxTalks Economics is a Talk normal production. The assistant producer is Megan Bieber and our editor is Andrei Zagarian. Next time on Vox Talks Economics, World War Trade.