Bank of England's King Sees Need for More Precautions

Bank of England Governor Mervyn King said Monday that new, tougher bank capital and liquidity requirements aren't sufficient to stop another crisis from occurring and it is vital to take further precautions.

In a speech at the Buttonwood Gathering in the U.S., Mr. King said he saw merit in having a basket of different measures that could be used to curb excessive risk-taking.

He also floated the possibility of "more radical reforms," including moving to far higher levels of capital requirements, and splitting retail and investment banking.

"The guiding principle of any change should be to ensure that the costs of maturity transformation—the costs of periodic financial crises—fall on those who enjoy the benefits of maturity transformation—the reduced cost of financial intermediation," Mr. King said.

The BOE governor said there was a "sound case" to impose a permanent tax on maturity transformations, as has been discussed by the Group of Seven developed nations and introduced in the U.K. However, a key obstacle in doing so would be to calibrate a suitable size for the levy.

As such, it might be better to apply controls on the quantity of lending that takes place, Mr. King said, adding that limits on leverage had "much to commend them." The challenge, he said, was to set the requirements in a way that would "materially" affect the probability of a crisis.

Another option would be for regulators to ring fence the activities they most want to protect from disruption, which should reduce the costs of any failure of an institution.

"Whatever solution is adopted, the aim must be to align private and social costs," Mr. King said.

At meetings in South Korea last week, financial officials from the Group of 20 industrial and emerging nations agreed to fully implement tighter capital and liquidity standards that aim to avoid future crises and reduce strains if they do occur.

Mr. King said that while the Basel III agreement should be welcomed, even the new levels of capital that it requires are insufficient to prevent another crisis. That is partly because the levels don't take sufficient account of the benefit to banks from government intervention and the role of implicit guarantees during the crisis, and when sentiment does change, only very high levels of capital are sufficient to allow banks to obtain funding on anything such as normal spreads to policy rates.

Furthermore, the risk weights used to measure the amount of capital required are based on past experience, while the framework still focuses largely on the assets side of a bank's balance sheet.

He reiterated that a simple leverage ratio could provide a key backstop to capital requirements.

Mr. King noted that although the BOE would have liked an agreement to set capital ratios at higher levels in the longer run, it had no intention to require British banks to implement the requirements at a faster pace.