UK banks are holding excessively large “rainy-day funds” that could instead be deployed to boost economic activity, according to a top regulator at the Bank of England.

David Bailey, executive director of Prudential Policy at the Bank of England, told the watchdog had kicked off talks with international peers over how to simplify banks’ capital stack to free up billions of stored cash. 

In July, the Bank’s Financial Policy Committee (FPC) outlined a shake-up of the capital buffer system that centres on a “single buffer that is releasable in stress”. 

Firms are required to hold a multi-layered stack of separate capital cushions, which include strict legal minimums, specific buffers for major domestic firms and overall leverage caps. 

Lenders voluntarily stack extra discretionary cash – “management buffers” – on top of their baseline requirements to avoid accidental breaches. Bailey said a number of factors influence capital levels including a “rainy day fund, an opportunities fund [and] rating agency requirements”.

But banks were choosing to “hold quite significant management buffers over and above our regulatory requirements,” he said.

“The size of the buffer we see is larger than we’d expect,” he said, adding the Prudential Regulation Authority (PRA), the UK’s main banking watchdog, was looking to give firms “certainty” over their requirements to free up more capital to be pumped into the economy.

“That capital they’re holding could be deployed for supporting their customers and households… if you’re interested in growth, that’s viable economic activity they could be supporting.”

Bailey was tipped to lead the PRA following the end of Sam Woods’ tenure but is set to depart at the end of October. Barclays’ executive Katharine Braddick was named as Woods’ successor in February.

UK banking regulations come under fire

Top banks have hit out at the UK regulatory system for forcing it to hoard capital. A report earlier this year from the Association of Financial Markets in Europe (AFME) – which represents over 150 global banks including the UK’s big four – warned that the UK’s leverage ratio was a “clear instance of gold-plating”.

The rule dictates at least three quarters of a bank’s tier one capital – a core measure of a firm’s ability to absorb losses – must be made up of the highest-quality regulatory capital, known as CET1.

The AFME said the ratio “penalises good risk management and creates incentives to invest in higher risk assets”.

Bailey said he did not “recognise that description of our regime” and pointed to developments over the last 12 months including the FPC’s assessment of the “optimal capital” in the UK banking system.

He added: “If you’ve got capital set too low, then you run the risk of a financial crisis. Those things are expensive… and have a long-term scarring effect.”

“But also if you set capital too high, you can strain viable and productive economic activity… what we’re looking for is the sweet spot so we get the right level of resilience in a way that supports firms doing activity.”

Tory leader Kemi Badenoch has previously taken aim at what she branded as “buffer after buffer after buffer” piled on banks’ capital requirements. 

She pledged that the Conservatives would bring “capital requirements back in line with our competitors” if elected. 

The decision to set lender’s capital requirements rests with the Bank of England’s Financial Policy Committee (FPC), which would mean the Tories would have to legislate to pave the way for adjustments.

“We work with whatever parliamentary mandate we’re given, and of course would work with whatever government we have at any particular time,” Bailey said, when questioned about Badenoch’s pledge. 

“What I would say on international comparisons is that all the work that we’ve done when comparing with other jurisdictions has indicated that our regime (…) is comparable with the EU in terms of the outcomes it produces for overall capital levels, and below the US.”

He added the US had made “a number of changes” that brought it “more into line with where [the UK] and EU are.”

“So I don’t see major substantive differences based on the detailed analysis that we have done.”