Banks’ Capital Gap May Threaten U.K. Lending, FSA’s Bailey Says

Some U.K. banks may have a “capital gap” that could limit their ability to lend to businesses and households, said Andrew Bailey, head of banking supervision at the Financial Services Authority.

The gap, the difference between the book value and market value of banks’ capital, must be dealt with by regulators to ensure the U.K.’s economic recovery, Bailey said in a speech in London today.

“The danger of a very slow resolution of the capital gap is that new lending to the economy is seriously restrained,” Bailey said, according to an e-mailed copy of his prepared remarks. “This is the Japanese threat, based on the recent history of Japan,” Bailey said, referring to the country’s struggles to recover from its economic slowdown.

Lending growth has remained slow despite the FSA relaxing guidance on how U.K. banks calculate liquidity and capital buffers, according to the regulator. The FSA last month relaxed the amount of funds U.K. banks must keep in reserve in an effort to spur lending and stimulate credit growth.

The full answer to the capital gap isn’t yet clear, Bailey said today, and possibilities include encouraging lenders to raise new capital and to allocate existing reserves to growth- inducing lending.

“The choice of solutions matters because it can influence subsequent lending behavior,” Bailey told an audience of financial executives.

One option could be to encourage banks to issue so-called contingent convertible bonds, or CoCos, a form of fixed income security that would automatically convert into ordinary shares if a bank’s capital falls through a pre-fixed floor.

“I am quite attracted to CoCo’s, but we need to think through whether they will create the necessary incentives to new lending,” he said.

Bailey is CEO-elect of the Prudential Regulatory Authority, the planned U.K. regulator that will be responsible for bank oversight next year when the FSA is disbanded.

To contact the reporter on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net Ben Moshinsky in London at bmoshinsky@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net

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