Bank of England Governor Mervyn King said the deteriorating outlook for financial stability is holding back the U.K. economic recovery and banks should build bigger capital cushions and be ready to use liquid buffers.
“Uncertainty and tighter credit conditions have acted as strong headwinds to our recovery,” King said at a press conference in London today. U.K. policy makers continue “to believe that there is a need for banks temporarily to raise their levels of capital in view of the exceptional threats they currently face.”
The bank’s 11-member Financial Policy Committee unveiled five recommendations to enhance the safety of Britain’s banking system, saying that capital buffers may need to temporarily exceed requirements implied by the transition to Basel III standards. The panel said regulators should make clearer that banks can use liquid asset buffers in the event of stress.
“The crisis in the euro area has generated a great deal of uncertainty around the economic outlook and exposed severe vulnerabilities in the European banking system,” King said. “That’s been reflected in higher funding costs for banks and higher interest rates for households and corporates.”
Euro-area leaders today agreed to ease repayment rules for emergency loans to Spanish banks and relax conditions on possible help for Italy in measures to stem the region’s debt crisis. Disruption that could be caused from the euro area poses a “significant threat” to Britain’s financial stability, the Bank of England said.
“The outlook for financial stability has deteriorated, particularly in light of heightened uncertainty about how and when euro-area risks will be resolved,” the FPC said in a statement on the recommendations that followed its June 22 meeting. “Progress in building capital has slowed and market-based measures of capital adequacy have fallen.”
Among the recommendations, officials also said that banks should continue to restrain cash dividends and pay in order to build equity, while also starting work this year to improve accounting standards, including reconciliation of accounting and regulatory measures of capital.
The committee said banks should “work to assess, manage and mitigate specific risks to their balance sheets stemming from current and future potential stress in the euro area.”
U.K. bank exposures to sovereigns and banks in “vulnerable” countries such as Greece, Ireland, Italy, Spain and Portugal are “low,” totaling 12 billion pounds ($18.7 billion) and 30 billion pounds respectively.
Total gross exposures to private sector borrowers in those countries are about 145 billion pounds, or 70 percent of banks’ core tier 1 capital. British lenders have exposures of 30 billion pounds to Germany’s banking industry and 60 billion pounds to France’s, the central bank said. U.K. institutions could “face disruption through secondary channels.”
“The direct impact of a Greek exit and associated redenomination appear likely to be manageable,” the panel said, “But some other banking sectors are more exposed.”
The central bank has activated its Extended Collateral Term Repo facility to aid institutions in times of stress. U.K. banks are able to use pre-positioned collateral for the discount window in that facility. Pre-positioned collateral, after the application of haircuts, would be worth 160 billion pounds as of the end of March, the BOE said.
“The major U.K. banks have made progress in strengthening their capital and funding resilience,” the bank said. “Since the middle of last year however, the risks they faced have also increased significantly.”
Global banking regulators have provisionally agreed on changes to a planned rule for assets that can be easily sold in a crisis over concern that some risk models for lenders may have been too severe, according to two people with knowledge of the matter.
The Basel Committee on Banking Supervision discussed the standard, known as a liquidity coverage ratio, or LCR, at a meeting last week in Stockholm, according to the people, who asked not to be identified because the talks are private. Regulators changed some assumptions about what may happen to banks in another credit crisis, the people said.