They were sitting a bit above where they were before the before the crisis. They're now somewhat further above, but but they're still obviously crude prices. Crude oil prices are you are well down on their peak. Um we are also seeing I think you continued fairly soft evidence on the pass through into UK prices, but we'll get another inflation number next week. The one however other caveat I would add which I don't think gets enough coverage is that although crude oil prices have come down the prices of of refined products have not come down as much. So we're talking about things like gasoline and diesel at this point which of course are the end end products. So those are the things that matter in terms of the end products and and one or two of the reasons for that in the global context are that um there's a there's a story around China and obviously a story around Russia. China um has substantially reduced its imports of crude over the last month couple of months. That's been interpreted therefore as a sort of softening of the market and a sort of reduced demand story. But they've also as far as we can tell reduced their exports of refined products substantially. So in a sense actually they haven't necessarily changed their balance and that is tightening the market for in global market for refined products. And the other thing of course obviously and this is obviously you know good news in other respects that obviously Russia's had a serious serious blow to its capacity production capacity from what Ukraine has done. So there is I would make that caveat that we all spend all our time quoting crude oil prices but you have to be a bit careful because I don't think refined product prices have come down as much and one of the challenges of course is the damage to the infrastructure in the Middle East which can take eight to
well eight months minimum to get you know once there is a ceasefire that holds it's going to to take things to get things back on track. What modeling is the bank doing to look at the impact on the UK economy in the short to medium?
I mean, we obviously talk a lot to uh people in the industry and I we obviously talk a lot to our counterparts in the Gulf area. I I spend a lot of time talking to my counterparts. I think the story there is um take oil and gas separately. Um on the front, there hasn't been as much physical damage to the infrastructure as the supply production infrastructure. Obviously, the block the blockages in the Gulf are another matter. Um so I think the message we get from the Gulf States is that if they can ship the stuff out then they will they will resume production very rapidly and they have at least up until last week they had resumed production rapidly. They are also have got quite big plans which they're already executing for building uh new pipelines to get round the straight of hills um to to do that to get it to ports which are south of the straight but that will obviously take some time to do on gas um I think the story certainly stories we get from from the Qataris who are the people who matter obviously in that market are I mean they're quite precise I think they say about 80 I think they say about if I remember rightly about 83% of the of the of the supply is intact. Uh the 17% that was hit by the Iranians in the attack some months ago now will take longer to to bring back. They have they again too have got quite big plans for increasing their overall output of gas but that again they're talking about sort of 2029 2030 I think for that. So I say that they're they're clearly very determined to get supply back onto the market, but obviously what we're seeing in the straight now is going to impact that.
Okay. So it's a long a rocky period ahead. I'll come to some other witnesses on that in a moment, but we're about to uh have our seventh prime minister in 10 years. Um we've had a lot of change at the top there. So you know, we're talking about internationally, but domestically though, do you think those changes and all that upheaval is good for financial stability?
Well, I'm not going to comment on on on obviously on what's happening in politics. Um well, I suppose we let me say about the stability point.
No, but two things um which are important. One, um as the last few days have demonstrated, the big driver of moves in financial markets is actually not what happens in the UK, it's global. It's the global setting. Um what I would say however is that I think what the evidence does indicate is that you know the UK situation is sort of supported by you know on our side obviously monetary stability and financial stability and I think on the other side is is is the fiscal framework um and obviously you did see a bit of movement in markets briefly on the fiscal you know on needs on the fiscal framework but that that that that came back quite quickly
if you were to be you can't you can't give private advice to us in public but we've got a new prime minister, a new uh well a new government, a refreshed government I suppose you could say coming in next week. What would be your top tips in order to make sure that we have financial stability or or their best chance of maintaining financial stability in the UK?
Well, I think I think that the overall message I would give is that I think the big issue is is growth in the economy. So I think you we can do all we can do all we can on financial stability. I I and we'll come on to this no doubt. I do actually think you there are there are signs of of a very resilient financial system. We described them in the uh in the financial stability report and in two respects. One is you know I think I think for instance you know the core banking system is resilient and I'm sure we'll come on to discuss that. But also when you look at debt levels in the economy, if you look at debt levels in both the household sector and the corporate sector, I mean they are not stretched actually at the moment. So that's a you know that that gives us an underlying picture of resilience. What I think is much more challenging is that we you know we've had low growth in the economy now for you know best part of probably 16 17 years. Actually this is not this is so this is not a story about any one government by the way. This is a general story. It's not a you know it's not a political story in that sense but it is a story about UK growth. Um you know I've made a number of speeches recently on this subject I think it's important because it's the critical structural uh issue and and you know as far as I will um in a sense go into fiscal policy which is not far what I have said is look it is interesting that if we did a simple naive sort of counterfactual and said imagine that we'd had this the growth rate for the last 17 years that we had for the preceding period which was you know a potential in natural growth rate around two and a half percent a year. So we've been around one one and a half for the last 17. So imagine you, you know, you add that 1% back in. You've got the same shocks. So you've got you have exactly the same fiscal policy for every government. Not changing fiscal policy. You've got the same shocks at COVID, Brexit, Ukraine, Gulf, they all happen. Where would we be naively? Where would we be today on on on on debt on the public sector debt level? It would be about I think that number was about 10 percentage points lower now. Therefore, you're not you haven't you haven't sort of solved all problems, but I would I would argue I think you would it would be a very different debate.
Okay, that's that's very um helpful. Um and one of the um there was a strong drive here in the UK for deregulation of the banking sector to promote growth and when we meet with those financial institutions, they're keen to see that and constantly stress that we're a long way from 2008. Yeah. Do you think that that emphasis on deregulation and growth pose a risk for financial stability because sometimes that's the tension that's put to us by other people that the bank is holding back growth because they don't want you don't want to see that deregulation. Is that a fair comment?
My overall view on this is we will not get growth if we don't have financial stability. I mean I think we can point to episodes in history which support that view. So financial stability and monetary stability are key underpinnings of growth. Does that mean however that every one of our rules in financial regulation is perfectly formed? No. I mean it doesn't. Uh would it would that ever be the case? No. Uh because the world always moves on. Uh so do you know do we support a process of of review? Yes. I I do think that where I do differ from some some some of the the arguments that are put is uh let's take the banking system is important. You know the key to actually the banking system supporting the economy is to have a system that is earning you know earning returns which cover it more than cover its cost of capital which means that they can you know they can invest their returns to support lending and the economy and uh you know that is that is the best system we can have. I think we I think after a long period of rebuilding capital in the banking system post the financial crisis we actually are now in that situation. they earn more than their return on capital and you can see that in the market numbers you can see in the price to book ratios. Therefore uh you know they they you know they seems to me they have a you know a choice they can make as to whether they reinvest earnings into their own business or they or they pay them back to shareholders and that's a choice you know that should be made in the market. Uh we were not in that position before. The reason I push back is that some of the debates I find and you you read the debate, it's as if we've got this sort of fixed amount of bank capital and therefore we must sort of lighten regulation to allow it to sort of be spread around further. It isn't fixed. It isn't fixed at all. I mean, I say a healthy banking system will earn its returns and and they can be reinvested into the economy.
Okay. Well, they've heard that. Mr. Crosner, you do I mean from your perspective, let's take the look at the Fed. Does a a wash fed mean? What's it mean really for financial stability globally and in the UK? Do you think there's going to be any changes as a result?
So Kevin Walsh and I u went through our confirmation hearing together uh and to join the Fed and we sat next to each other for years during the global financial crisis. So he has been battle tested in financial stability and he's very aware of and sensitive to those issues. So I I'm obviously no one can uh can guarantee that there will not be a financial crisis but he is aware of and very sensitive to those issues. Uh obviously there's a lot of change in in financial regulation in the US and um a new proposal related to the the Bosel 3 endgame which I think is providing much more effective regulation and and I think it's it's very important not to confuse effective regulation with deregulation. It's um we want to make sure that regulations are effective, that they reach the financial stability goals, but also that banks can intermediate, that they can actually do lending, they can do what they're supposed to do in the economy. And I think that that's the key motivation for what's going on at the the Fed now and thinking about financial regulation. And I think from the more macro perspective, Kevin's going to be very much aware of those issues, is not going to do want to do anything that is going to expose uh the time that he is at the Fed to a financial crisis. But of course, sometimes events overtake what one wants. And certainly when I was at the um at the Fed, uh I had studied a lot about the 1930s. Ben Bernanki said a lot about the 1930s. I don't think any of us thought we would be in a 30s-like crisis, but um having studied that period, that was very helpful. And I think Kevin, as well as others who have been through that period, will make sure that uh we're best prepared. We'll be able to respond to try to minimize the damage if there is some sort of shock that causes a crisis.
Thank you. That's very helpful from someone who's so close to Mr. W. Jim Dixon.
Thank you, Dane. Meg. Um just looking at other risks that we're facing at the moment. Um we're just at the end of our well sort of in the middle of the third uh wave of extreme weather uh of this year. Um so clearly climate change is sort of front and center for all of us on thinking about the way in which uh the country and the world is developing. Renewable energy India's fastest growing opportunity industries company solar power project official commissioning August 2026 expected
the recent uh focus on climate change has changed your view on that at all.
Well I made I was making a relative point um I'm not wasn't making a point about the absolute level of climate risk. Um I was making a relative point. I'm going back to the chair's first question. I mean given the what we've seen on for instance on frontier AI of over the last few months I sort of have to make that point again. I mean look I I I'm not a climate scientist myself. So I'm I'm not going to venture an opinion on what we can conclude from what we've seen in the last few weeks. But we've obviously had a you know Europe has had a very strong period of very hot weather. Um so uh you know I think it does remind us that there are very clear risks from from climate. Yeah.
And either the governor or other financial institutions in a way that we should be taking notice of. Um would anyone want to Mr. Benjamin that?
So the the the channels in which uh climate change uh affect financial stability haven't changed. They remain uh very present. They are risk to banks. there is two insurers and there is two core markets from climate change. this uh this hasn't uh changed and part of our uh analysis is to gradually embed this analysis into the mainstream of how we test financial stability and we've still got sort of strong teams of uh staff at the bank looking at those issues and understanding the analysis that you're talking about because I I think the governor last time we spoke you said there were now and you accepted there were now fewer staff perhaps working on those issues and that might indicate a sort of a kind of lesser emphasis on them which was a bit concerning.
No again I I I make this point I we have to actually you know allocate our resources to reflect sort of the relative risks as well and and and for instance AI has come up the lead table very rapidly. Um
we'll come on to AI momentarily. Catherine West
thank you very much D meg. uh on the point of AI, what assessment has the B bank done on the needs around water um particularly internationally in countries like Malaysia where you know it's such a big part of the economy now but the physical needs around water etc that will if not handled correctly could have an impact on economic stability what assessments
I I'm not sure we I'm not sure we're the experts on on on that one particularly to be honest
Benjamin there there's one aspect this in your organization.
I'm not an expert either but there is one aspect in which and it is related to AI in which uh the availability of water supply uh does affect uh those developments. It is uh we've all heard about the very large increases in the in the infrastructure of data centers that are being planned to develop AI capabilities. those large data center will require water supply in order to cool down uh the the the production line. The the needs for water are large from that. And one of the questions are whether the water infrastructure will be sufficient uh to meet the the needs for those developments at the pace that is currently embedded in the expectations of the markets.
What assessment has the bank of England done on the demand on the grid for AI in the UK and what impact that might have on financial stability? if certain types of projects don't go ahead but AI is demanding that
yeah can I make two points I mean I think it's part it comes back to this question of growth so if and I I do subscribe to this view that you know because I do think technology I made this point about lower growth over the last sort of 17 years I do think technology is part of this because I think in the long run technology is one of the drivers of growth I think we've probably globally been somewhat between sort of technology sites So we had the internet cycle um internet ICT cycle I think the next cycle is like to be at some combination of AI and robotics. So I think this question about uh you know grid capacity and data center capacity is is relevant here in terms of supporting growth. The other point I make actually this is a point I have to be honest I I'm not you know not being an expert in this field I hadn't appreciated until going around the country and talking to people and who are closer to this that there is also a question of what's called access to clean power supply now clean I'm using clean in a slightly different context to the environmental point here it's actually the quality of the power supply um in other words the sort of the the the sort of having a sort of very high quality and very continuous power supply. Some people have made the points to me and I think this is on their own at the moment renewables don't don't on their own give that quality that clean power supply. They can be part of big part of it but they don't they don't on completely solve that problem. You need a a base load of of other power to to make sure you've got that clean power supply. Um so again I think in thinking of and that's true for data centers. So I think thinking about that then I think there does need to be thinking about how you ensure that we've got that mix of power supply.
Thank you very much John Glenn.
Yes. Can I um turn to the decision to ease the leverage ratio by 02 percentage points. Um I want to try and understand the range of views uh that exist on this because I understand that well it appears to be a split decision and the quote is most judged that the benefits of the proposed changes outweigh the costs. It's um it would be useful to understand what the range of views were and you know how meaningful that range is in terms of decisions. Let me start with you um government. Yes, I'm happy to do that. Um, just to put into context, I mean, what I I think the the announcements we've made on on the leverage ratio are, in my view, really about sort of cleaning up some of the issues around the leverage ratio. There was a particular issue where we'd made some changes back in 2019 which I think had created an anomaly which was particularly affecting the large domestic banks. Um and that's important because they are the people who make you know the highest proportion of lo loans into the UK economy and it it had left them facing a higher leverage requirement than was was I think justified. So I think cleaning that point up was important. Um we've also I think increased the buffer usability in the in the leverage ratio which I think also is important because it's exactly consistent with how we operate the risk weighted ratio. Now the one thing I would say is it of course the risk weighted regime and the leverage regime are not additive they're parallel. Yeah. Um that's important. So yeah we made some changes to the weighted regime when we were here and we talked about them in December. Yeah. These these are changes in the sort of the parallel regime. Now the question though is this. So I think those things for me those things were all sensible things to do. The challenge we've got and this is why you you know there's there's some quite important words in the in the announcement which I'll come to is that we've got an issue with leverage in another context which is leverage in financial markets. Um we've talked about this I think in previous hearings in the context of particularly of government debt markets. What we've seen in the last in the period since the last hearing uh and in recent months is also a growth in leverage in equity market leverage. So in hedge fund leverage and equity markets also in leverage in exchange traded funds. So there's a there's a further growth in that world. Now that's le it's all leverage but it's a different context for leverage but these two things are connected in the sense that the banking system is the ultimate sort of provider of liquidity and therefore there are exposures between these parts of the system. So I think the question that you know for me the question that we rightly debated at length in the in the committee was is the better way if we think we need to t do something in that market leverage regime is it better to do it in the banking world or in the market world is it better to tackle this market leverage question in the market sort of regulation world if you like or in the banking regulation world now my own view it's a personal view I think it's better to do it in the market world but we've got to learn that because you know we've put out some ideas got mixed responses. I'm not surprised. But you'll see that final thing I'll say you'll see that we've included some language which actually means we're going to do a bit of further work before we finalize these changes which is exactly to this point and it's particularly to say do we think these changes might actually increase the market leverage risk. Um and and frankly the additional question will be if if so but it's a question we've already got. what are we going to do about it in the market leverage world or do we do something in the banking leverage world so I think there sensible changes to make those in their own right but we have got this outstanding question about what we do about market leage
okay so who can help me understand what a slightly complimentary view to that is amongst the wis
so um I mean I I think the the aim of the change to the leverage ratio framework to fix this idiosyncrasy that was a result of an increase in the counteryclical buffer in 2019. There was an offset in the risk weighted stack of capital. There was an increase in the counter called leverage buffer. There was not an offset in the leverage stack. So that was a uh discrepancy and that disproportionately affected the uh domestically systemically important banks. So I think the there was unonymity on the committee that that was something to fix and that was uh that's what's been achieved by this package. There's also a broad view that we want to be getting the overall balance of the risk weighted capital requirements and the leverage capital requirements uh correct. The the the other view is that in addition to fixing the uh discrepancy for the uh DIBS, the domestic which makes a lot of sense and will support lending into the UK economy, there's also a slight reduction in leverage ratio requirements for some other institutions and that could potentially lead to uh further uh provision of leverage into into markets. So that's the the question about cost and benefit. To the governor's point, I agree that there are um mechanisms within the the markets in particular um haircuts or margining on repo that would actually be I think very effective for um providing stability in in markets that can be in some ways arbitrarily levered if you have no haircut on a on a repo transaction. And you know the leverage ratio won't fix that if you have um essentially no haircuts on a repo. that's that's arbitrary leverage. So that's the uh that was the the balance in in my view of of the view.
Yes. Thank you. Um so we had an excellent discussion that I think got us to a very good uh a very good outcome exactly as the the governor and Stephen have said key motivation was to sort of make the uh the leverage ratio more effective and make sure that it's doing what it we want it to do which is to prevent excess leverage in the banking system. But um I um I also believe that this is not the right tool to try to deal with market. And so um I I think that what we were doing is trying to make sure that we had a lot of things that could be released in a crisis. Getting back to the previous question, that's a very effective way to try to make sure that banks can continue to intermediate during a crisis and provide um both support in the crisis and more rapid recovery. And um and so and a 20 basis point change in the leverage ratio does not seem to be material to me in uh changing the ability of banks to either provide leverage more broadly uh well just within the domestic economy or more more broadly. and we have much better targeted instruments. So making the capital stack much more in the capital stack releasable that also is something that is very helpful in achieving uh not only the financial well the we obviously have the our main objective being financial stability but also in providing um support for a secondary objective on credit um provision and and growth because that's something that will allow the banks potentially to reduce the so-called management buffer that they hold above and beyond the required minima. Now, of course, they're always going to hold something beyond that. They shouldn't be running right at the edge. But when there's a lack of predictability, when there's a lack of clarity about what is releasable, how much it has to be rebuilt, how uh that's going to operate, that leads them to hold a bigger buffer against that and and I think the the approach that we've taken will help to reduce that. So make the uh the leverage ratio more effective without in any way affecting the uh financial from my perspective affecting financial stability and not addressing the the market risk issues which we'll do through separate means.
Can I can I just come on to um the decision about lowering the um capital requirement from the 14% of risk weighted assets to 13%. Because I think there are two broad set of views there. Those that obviously think that you know this is um you know well where does the benefit go to in terms of to to to the banks um uh or or their shareholders or to the economy as a whole. But there's also I think still significant dissent among amongst many banks over what is the actual net effect of this because there are so many a so many caveats that the notional 13% is never met because of all the different elements that go into it and people then say well if you look at the bolder measures made in the US we are not really getting to there's still quite a margin between where we are in these the consequence of this change and what is actually happening in in other environments. How do you respond to those observations?
Well, I would I would disagree that the US has taken bolder measures. I don't think they have actually. Um I mean the latest package they've announced is to implement uh Barcel 3.1 uh which obviously we're doing as well. Um we've published a number of comparisons. We've actually in the latest numbers compared the leverage ratio comparisons. Um the leverage r actually higher for international banks. Um so I would would disagree on that point that the US has done has done bolder things. Actually I'd say the same about your area. I don't think they've done anything anything bold than we have. Let me make two points. Um I think I think I just re the first one is just to reinforce what Randy said which is you know we know that banks maintain you know what they so called management buffers above our requirements um and as Randy rightly said there are reasons for doing that which will be about how they run their businesses um and that's that's understandable but I think what we've done is will enable them to to have more confidence to you know to reduce those buffers and certainly you know that's our aim. But same point, we've we've actually we actually included a a diagram in the publication we made. We would like to see the buffer structure simplified. So talking about bold things to do. It is too complicated at the moment. Um we would like frankly a single buffer and a single releasable buffer. The reason I think releasibility is important is that the thing that I think banks always worry about if if we don't release buffers and if we say to them look you know it's okay to go into your buffers we won't get upset um they always come back and say well will you you know um so the stronger the strong they always say look the stronger thing is if you're prepared when you know when conditions change to take the buffer away except that there'll be a rebuilding process at some point further down on the line. That's a stronger message. So, we'd like to see that and we'd like to see it simplified so there's only one of them. To do that, we need international agreement. The buffers are buffers are a product of the international structure, the Barcel structure. Essentially, we are and and Sam Woods when he was obviously with us made, you know, made speeches on this subject. We've been leaders in advocating that um we will keep working to get an international consensus to tackle the buffers. We're not quite there at the moment. Uh but I think that's the that's the bold thing that that should be done and to say we're strong supporters of doing it.
But when but when banks look at the what their effective situation is, they tell us that they they never get to that amount because of all of those add-ins and uh overlays that that actually occur. And so whilst I understand the aspiration to simplify and have a a a single buffer if you like the the reality is that because of their hesitancy around you know the implications of not doing this in the right way. They don't and the net effect is they end up holding more than they feel they ought to. And that is a you know persistent narrative that they bring to us and members of this committee have have had that you know drumed into them at private meetings recently.
Can I can I just let's let's take that let's let's sort of pick that argument apart for a moment. Um why do they say that? Well, there there there are at least three reasons I can think of. One we've already covered, which is that they main they maintain so-called management buffers above what we require. That is their choice. Uh but I recognize there are things that we can do to simplify the structure which might assist them to maintain smaller management buffers. I think they'll always have them, but they will have smaller ones. Randy touched on this. Uh and I think what we've done is steps in that direction, but as I was just saying, I think the big step in that direction would be to move to the single buffer if we can get international agreement. That's the first thing. The second thing is look capital ratio capital requirements will differ from bank to bank partly because of what the business they do and partly I'm afraid sometimes because they demon they fail to demonstrate to us you know the characteristics of running the business that we expect. So we do sometimes put add-ons in this is in the Pas world more than
Can you give an example of that?
Well, yeah. If they if they show they can't manage risk adequately, um yeah, our supervisors can can put on
that is an active Yes, that happens.
we should go back to the banks and Yes.
Mr. Benjamin is nodding. I wonder if Mr. Crossers who's been
get your act together. Um
Absolutely. I mean they can also get higher capital requirements back by bank because for instance they have greater concentrations of risk in particular activities. That's again a reflection of the risk they're taking. So that's the second point. Then the third point is is sort of the fundamental one. I think many of them still think that 13 is too high. Now I want to come back to points I made actually early on to the chair's question. We will have a a strong banking system and they will earn strong returns if they are you know well capitalized. They are lending into a strong economy and they are earning the returns. Now I think the evidence is that they you know they are in a strong position. I mean I mean look there were a lot of complaints frankly about how much they're earning. Yeah I you know I've said look they have to earn their cost of capital. They are doing that actually doing some more than that. That's a sign of their resilience. So you know the the capital system does support their resilience. I mean they don't like I mean they will never say that not every love story begins with a grand gesture. Some begin with the choices you make that define your worth defining the woman you become and then you realize the greatest love story begins with you. Ra by Titan presents Paris with love. not include the exclusion of unencumbered guilts when looking at the regional the leverage ratio denominations.
That's not in Basel. No, Barasel does not. Nobody does that. The US doesn't do that. I mean excluding guilts from the leverage ratio. I know they'd like it, but frankly that's not in Barasel. It would be contrary to Barasel. Nobody does that.
Thank you very much.
Did Mr. Crosno, did you want to come in?
So I think this is one of the reasons why we have stress tests to um and and make sure that they do have appropriate risk management and most banks do pass a stress test now. So it's not worth setting a barrier or a hurdle that is so high that is unattainable that no one can get an A in the class. Um now most of the banks are getting an A in that. So they know how to achieve that and I think it's completely appropriate that if they are taking undue risks then they should have add-ons. if they have processes in place and sufficient capital and uh appropriate risk management then they are free from that but the fact that major UK institutions have an effective requirement closer to 14.25% 25% rather than 13%
In reality is really just a function of them not operationalizing risk management appropriately.
Well, it will come down when Basel 3.1. I mean part of this is that Basel 3.1 will reduce that. Because when we went from 14 to 13, we were actually marrying up top down and bottom up. The FPC does top down, PA does bottom up. The bottom up element is coming down consistent with 14 to 13, and a good part of that is Basel 3.1, and that's why the FPC felt it was sensible to match the top down.
Could I ask you, Mr. Crosner, about this? What banks tell us about the apparent gap with the US that the governor pushed back on? Some of them have said that UK banks now face a 190 basis point capital premium compared to their US competitors. You can dispute the quantum, but do you recognize any meaningful difference between the US and the UK?
Many different ways to calculate those sorts of comparisons.
Yeah, that's how you sort of get out of jail on this subject.
Yes, yes. And one of the challenges is that accounting is very different for what are considered bank assets, so that becomes a challenge to do international comparisons. I think we've been trying to undertake a review, and what we put into our reports is looking at international comparisons. The UK is a major global financial center and it has to be competitive, and I think we very much take that into account. I'm very cognizant of that and bring that into the discussions. But when we get into the specifics of where there's 190 basis points or minus 10 basis points, that becomes a bit more of an art than a science.
Do you think we'll ever get to a point where it will be apples and apples and you can make a reasonable comparison, and we'll stop receiving all these representations from the banks? It might be worth if I mean that may want to come in because we published in December a detailed comparison, I think the most detailed comparison.
You brought to the feedback that we've had which is where they make these points to us.
Yes, right. And there has been a range of feedback coming from different sides. So I think the fact is that with the package we have now set out, this brings in line UK capital requirements with requirements in other jurisdictions in a way that is consistent with the analysis we did and consistent with the feedback we received on this point. I think the other point to note is often US banks. I used to supervise US banks. US banks hold internal management buffers above their regulatory requirement actually much more than some of the UK banks, and yet that doesn't have a detriment to their earnings or profitability. This is sort of...
Just very briefly, we also hear this in the US, the international comparisons. The US banks always feel that they are being unfairly gold-plated. So I think it's a natural thing for domestic banks to go to their domestic regulator and say look at the others, they get away with this, we don't get away with it. I think you would hear a very similar thing if you were sitting in the US Congress.
Sounds like managing teenagers, but that's a bit... One more question around the net effect of this in terms of to the banks and the bank shareholders or to the economy as a whole. In terms of the narrative that they bring to us, that if they can actually get access to more money to lend to grow the economy, yet we see banks doing quite well in these circumstances. Do you have any views on how we should review the performance of banks financially?
I do push back at this, what I sometimes call the lump of capital argument. That goes on, which is this idea that they've got a fixed amount of capital and if only we'd lighten the regulatory regimes they could sort of... I recognize we went through a period up until only about two or three years ago after the financial crisis where they were not earning their cost of capital, and it was very hard to go to the shareholders and say you should leave this money in the business because it's a good thing because the shareholders say well it's actually not a good thing because you're not earning the cost of capital, I can take it somewhere else and find somebody who is. But that's not true anymore. They are more than earning their cost of capital, and the best illustration of that is the price to book ratios. They're now on average about 1.7, whereas they were below one. So they're in that position. So they can, I think, they are resilient. That's why as we've talked about stress tests, they pass stress tests. They can make choices now, and the choice they can make is to support lending into the economy with those earnings. And that's what, to my mind, they should be doing. A resilient system will support that. It will support the economy.
I'm just going to bring Mr. Live. I think he wants to come in, and we just need to wrap this section up because we could spend forever discussing capital and banks. I'll bring in Mr.
Thank you. I just wanted to bring attention to that we've published the feedback from a very broad consultation about this matter, not only from banks but from academics, from rating agencies, from bank analysts and bank investors. I think that is a very rich picture, and it's clear that banks will, all things being equal, prefer to have less capital and less requirements. I mean, any investor or risk taker would like that. And I think that what we heard from academics and bank analysts in particular is their arguments that the capital should be higher and actually bringing it down is not the right thing to do. So I think this is quite a balanced argument. From rating agencies and bank investors, they say we look carefully at the capital people are holding and we want to make sure that's appropriate in order to invest in these banks, and I don't think their view is that the capital levels should be going down.
Very helpful, Chris.
Sure. Governor, you sound slightly skeptical about the banks' position on this. Of course, in 2008, banks were making the exact same argument that you need to just deregulate, lower capital, and everything will be fine. The economy will grow, and in the process they crashed the global economy. To what extent does that history inform your thinking now?
Well, it does a lot, actually. So I'm realistic enough to know that memories of the financial crisis are now disappearing sort of into rearview mirrors. Some of us probably have undying memories of it, having had to deal with it. But they are disappearing. And so you have seen this in history before. You get these cycles, and I think we are seeing this where people now saying the response to the financial crisis was too great and too strong. It didn't feel like that at the time. I have to tell you, when we were dealing with a system that was extremely weak and having to rebuild it. I get people saying but you've solved that problem, you should move on. And I say yes, in the sense that I think the system is now resilient, it's rebuilt, but the idea that we therefore relax the standards because it's all over, no, that's not the way it works. So I'm philosophical. This is a debate we have, and I just come back to this point: I'm not going to defend all our rules as perfect. They're not. But the central point is we will not have a strong economy without financial stability.
Very much indeed. I'm just going to move on because we could go on forever discussing this, but we do have other topics. On the subject of AI, which we parked at the beginning, I'm going to bring in Bobby Dean.
Thank you, Chair. Yeah, Governor. I'd like to return to something you made a point of highlighting in your opening remarks, which is about the heightened risks around frontier AI. I think critics will say I told you so when the discussion started talking about AI a few years ago and it was kind of leveled down as another risk to manage, and now you're saying that it's grown much faster than you anticipated. So what is it that you didn't foresee previously?
Well, it's not just us. I mean, if you talk to the people who run Anthropic, OpenAI, they will tell you that the advance that they've seen in these models in the course of the last months has been much faster than they expected. They draw these exponential curves, and they're saying we've now moved into this vertical part of the exponential curve in terms of the advances of these models. So they too were taken by surprise. So if you take Claude, which was the Anthropic model that really kicked this off back in April, and I've talked to Dario Amodei about this, they were surprised by the advances this model made. The reason is that these models are self-learning, they do this recursive learning process. So it's the speed and effectiveness and the ability of these models that has moved dramatically forward. And when they are subjected to the tests that the AI Security Institute in the UK, which is absolutely world leading on this, subjects them to, when they test how effectively and how quickly these models are solving and developing, what they can do and the speed at which they can do it, I think we can all accept that the reality has moved much more quickly. But we obviously had an inquiry into AI and financial services, and I feel that we heard evidence about the potential advances in AI and how they felt that the financial service sector was perhaps underprepared for the potential movements. The fact that this happened more quickly than anticipated is one thing.
But one of the things we heard from lots of regulators at the time was that actually our existing risk frameworks are fine. We can be technology agnostic. Do you still hold that?
Well, I think there are two things here that are both related to AI, but they need to be kept separate. So on frontier AI, we're talking about cyber very specifically. To use a sports analogy, frontier AI will strengthen the defense and the offense. So if you are a bank, you can put frontier AI to work to strengthen your defense because it will find the flaws that have been buried in there for such a long time, and you can fix them. Unfortunately, if the offense gets hold of it, they will do the same thing to attack you. The whole thing at the moment is can we make sure that the defense gets strengthened effectively before the offense, and that's getting much more challenging. The second thing, which I think you're referring to, is equally important. This is how banks use AI. So we're not talking about cyber here. We're talking about how they use it and the risks that come with that. That's equally important, and I think your report was very helpful and very good in this respect. We are very actively engaged on that subject too. I think my sense is that banks are using AI a lot more. That's a truism, but where I think it's still more talk than actuality is things like agentic trading systems, setting up your own agents. I think that's right because there are some very big questions still to be answered about how that world would actually work. For instance, I'm not a lawyer, but the thing that strikes me is if you have an agentic trader trading system as a bank, and going back to frontier AI for a moment, what frontier AI demonstrates is that the recursive learning capacity of these systems means that they actually develop their own abilities. And as my colleague Sarah Breeden has said, we don't invent this, we get this from the firms who are developing it. They learn to cheat and they learn to lie. I'm sad to say. Where do they learn that from? Partly inherent in them and partly because they're trained on a set of past experiences and they cover things up. Now, if you've established an agent, you've got to be very clear where the legal liability rests in all of this. So I think there are things that will need to be resolved before that really develops.
Mr. Pedum, if I could turn to you. We might want to continue with the governor's World Cup analogy about attack versus defense. What are firms' current access to these frontier models? Presumably they're on the defensive side of this equation. So how is their defense?
So the financial sector generally has been putting a lot of focus on these things. What is happening at the moment is firms are in the process of testing those types of capabilities on their own systems. The big risk that comes with frontier AI development is the speed at which weaknesses in IT estates can be identified, and therefore what that means for patching and the speed at which software upgrades need to be made. So that is the work that is happening. Andrew mentioned earlier things that give the edge to the attackers versus things that give the edge to the defenders. One of the key aspects is the speed at which those capabilities become accessible to the attackers. They are typically accessible before to the defenders. So this buys them time to identify those weaknesses and to prepare for much faster patching because another risk is that the moments when software are upgraded are also the moments where there is greater risk of disruption, not because of an attack but because of the effect of the upgrade itself. So this is the work that is happening within the banks and within large firms at the moment to get them prepared for this new state of the world. We've been talking about risks in the abstract. Could you describe to us what the impact would be if the attack got there first to a standard financial firm?
Two ways cyber tends to manifest itself. One is those who want to disrupt systems, and then often there's a blackmail effectively. The other is stealing information. Those are the two things that can go on. As Matt was saying, what is being found is that flaws that have existed in very core pieces of software in the world, and this by the way includes financial systems, have often been there for a very long time, can be discovered by these systems quite quickly. I don't think the people who know much more about this than I do think at the moment, going back to the football analogy, it requires a lot for an offensive party to set this stuff up. It's not like you go home and get Claude, plug it in, and off you go. But the second issue is that we are now on this vertical exponential curve, they say. These models have a shelf life of only about two or three months and then they are replaced by something even more powerful. I know that if you talk to the developing firms, they say there are going to be open source versions of these things coming on to access, which will mean that it's much harder to restrict access to them. And then other regimes are developing their own, and China is the big case there. They may be some months behind, but they're not that far behind.
Bring in Mr. John Brady just for one quick question.
Governor, you mentioned legal responsibility for agentic models. I'm a recovering lawyer. If a bank uses an agentic model and it starts cheating and lying as you described, are we clear about who is responsible? Because I don't want to derail the whole hearing.
Well, I'm not a lawyer, so let me give my understanding. Let's go back to basic principal-agent law. If I'm the principal, you're the agent. In the traditional sense, I give you a remit to act on my behalf. I am liable for what you do when you dispense my remit. If you go outside my remit and start doing other things, you're liable. That works when you and I are both legal persons. But with an agentic AI model, it doesn't work because it's not a legal persona. I think it's normally the case that if the agent does something outside the remit, the principal is liable where the agent is not a persona. This hasn't been tested much in the AI world, but if that is the case, then the banks are going to have to think very carefully about how they manage the use of agentic AI because if they're going to be responsible for everything it does and it can go off-piste, then they've got to think that through before they start using this stuff. That's the limit of my knowledge, to be honest.
To come back to us in writing on that important point, probably.
Yeah, of course. There are the third parties that are involved as well, the AI companies and some of the major tech companies.
This I mean, if we move on to a slightly separate point, which is the critical third parties regime. I think there will be four brought into the regime now. A concern that has been raised is how much oversight you are actually able to have over these firms when they are quite opaque about the technologies that they hold. Mr. Benjamin, I don't know if in your capacity, what is your relationship with these providers and how much do you get to look inside their black boxes to understand what the real risks are?
The regime is coming in place now, and our colleagues on the PRA will be the ones supervising them. So that is going to begin, and we needed the regime to be in place first before coming.
Are there general concerns about working with these providers and how much information they are willing to share about their systems?
No, if you are referencing the four that have been nominated, I wouldn't say there are concerns at all. We've had relationships with them, we've had discussions with them for broader reasons in the past, and they are very open to those types of discussions. So I'm not worried about that.
I guess my point is more about regulatory capacity. I'm sure they will appear to be very open and willing to cooperate, but does the bank have the staff, the knowledge, the know-how to be able to properly hold all their systems to account?
So we have our colleagues in the PRA who have entire divisions of people specialized in operational resilience and well versed in these technical topics.
Okay, I'm going to move on to a slightly different threat that is still related to AI. Perhaps Mr. BL can speak to us about this, which is growing concerns about the threat of an AI bubble and the impacts that could have. The easy comparison is that of the dot-com bubble. Are the risks similar or worse?
It's a good comparison in terms of the level of concentration and heightened valuations, especially in equity markets. The continued increase in equity valuations, especially in AI stocks, has been constant with very strong earnings, but the current valuations are predicated on a very optimistic future earnings path. So it's not clear that it's necessarily a bubble, but it is in our estimation, and the bank's estimation, based on quite an optimistic path going forward. So if earnings aren't realized along the optimistic path, then there could be a significant repricing of AI equities. On that point, can I put to you that JP Morgan said something like $650 billion worth of revenue per year would be needed to get a reasonable return. They also remarked on some of the physical limitations in ever being able to achieve that kind of revenue because of water supply and data centers. Is that something you recognize? Do you think that the returns required are actually physically impossible to get?
I wouldn't say they are physically impossible, but we are very cognizant of the risk both power and cooling.
How will we unlock economic and social prosperity through environmental responsibility with EY's full spectrum of services across sectors? We're all in a positive earnings story. And from a financial stability question, there are two elements that are particularly concerning. One is that the funding for a lot of AI expansion is now going in debt form rather than equity form or from cash flow. So the growth in 2026 has been extreme, and obviously debt can have a lot more impactful downside if there is a popping of the bubble. The second is there is a lot more leverage, which we mentioned before, but leverage on the long side in AI equities, both institutional and retail. So institutionally, a lot of levered funds, hedge funds, have been taking long positions in these equities, often funded either in derivative form or by prime brokerage. On the retail side, a lot of levered ETFs. So this means if there is a fall in equity prices, that can lead to a negative spiral. So from a financial stability point of view, market volatility is not per se a financial stability concern, but when it can be amplified rather than contained, then it does, and I think those risks are growing on the AI side.
And that change towards high leverage positions has happened very quickly over the last year or so. We got information about Alphabet's position, for example. Does that make you feel that a potential bubble burst is much closer than it was this time last year?
Again, it's hard to predict, but I do think the impact of a bubble burst would be more significant given that leverage. The pace of change of leverage is remarkable. The data on prime brokerage increase, that is remarkable. The pace of growth in levered ETFs is remarkable, and the pace of increase in debt issuance is extraordinary. So there are many things we should be thinking about. One is whether this is crowding out other debt issuance because there is so much debt issuance coming in AI. Is this actually increasing levered long positions to the AI story across the financial system? If that levered long position means greater interlinkages when the bubble bursts, it's hard to say about the probability of a valuation reset.
Can I just ask you about the UK's specific position in relation to this? Obviously we don't have so many developed AI firms, but we would still be exposed to any impact. There are two sides of the coin: the risk of that bubble bursting and what that means for the UK, but also in the meantime, what is it doing to our growth prospects if so much capital is going in one direction?
Well, even if there was a bursting of a bubble that is primarily not located in the UK, the market effect is so large now that it clearly would wash over. So I think that's right. We ran a stress exercise that looked at this question and it did reduce UK growth. Exactly how the effects would run through, you would expect some adjustment in UK macroeconomic policy, which is another way of saying you might expect some adjustment in interest rates to reflect that. So yes, it would wash over on the UK growth side. Let me add two points to what Stephen was saying. First, history tells us with these big general purpose technology innovations that it takes longer for them to come through into productivity and growth than people think. This one may be a lot quicker because the pace of change in AI is clearly accelerated, but you go back to Edison inventing electricity, it took a lot longer. You go back to ICT, the famous Bob Solow comment: you can see computers everywhere except in the productivity statistics. That is one way of saying it takes time for these things to come through. The second thing is everybody is currently priced to win. Everybody doesn't win in history. The first company that got the biggest share of internet browsing wasn't Google, it was Netscape. In terms of the UK, I think it's important that this is a highly globalized market for these things. The UK does have real advantages in this area. There are centers of expertise, a university system that is a strong producer of research and outputs. We have a very encouraging state of affairs at the moment on tech startups. Patrick Vance was saying to me the other day we think we have the most ever in this country. I think the persistent question is the next stage: how you go from startup to scale-up. That remains a big issue in this country.
You want to come in or not? Okay, that's fine. Chris M.
