25 Mar Banking Solvency ratios

Over the last week there has been plenty of headlines around a potential mini banking crisis and the breaching of solvency ratios. But what do these ratios mean?

After the last financial crisis in 2008, the Basel III international regulatory accord (made up of 28 countries) introduced a set of reforms designed to improve the regulation, supervision, and risk management of the banking sector. It went further in 2014 and introduced the commonly used Tier 1,2 and 3 ratios. The Tier 1 ratio (CET1) requires banks to maintain liquid capital to exposure (lending) of 4.5%. The good news is the main 4 UK banks all comfortably exceeded 15% in 2021.

Confidence is the great enemy to these ratios as customer withdrawals restricts how much a bank can lend and this credit crunch can rapidly creative a self fulfilling downward spiral. The central banks have learnt a lot since 2008 and the speed we have seen them step in as lender of last resort seems to be the most effective way to stop this wave in its tracks.

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