BOE Proposes Power to Target Risks in Mortgages, Derivatives

BOE Proposes Power to Target Risks in Mortgages, Derivatives
Lights illuminate offices inside the Bank of England in London. Photographer: Chris Ratcliffe/Bloomberg

The Bank of England’s Financial Policy Committee proposed powers to alter the amount of capital banks hold against real-estate assets as well as derivatives and bonds as it seeks to strengthen the financial system.

While the FPC will seek to act at the “highest level,” it also sees a potential need to target capital at a “more granular level,” it said a draft paper published in London today. “Such an approach might help to tackle threats to stability before they spread, particularly by leaning against exuberance in specific subsectors,” it said, noting high loan-to-value mortgages as an example.

The FPC has sought powers over so-called sectoral capital requirements -- along with countercyclical capital buffers and leverage ratios -- from the government as the Bank of England prepares to take over the role of ensuring financial stability. The committee, led by BOE Governor Mervyn King, is currently operating on an interim basis as legislation passes through Parliament.

The FPC said the use of the countercyclical capital buffer and the sectoral capital requirements “will improve the ability of the financial system to withstand shocks.” King is due to appear at a Parliament hearing in London tomorrow to answer lawmakers’ questions on the BOE’s semi-annual Financial Stability Report. FPC members Andrew Haldane and Michael Cohrs will also attend the hearing.

Enhanced Powers

The CCB tool allows the FPC to change capital requirements “above normal microprudential standards in relation to all loans and exposures.” The SCR tool is “more targeted” and allows the FPC to change requirements for specific types of assets. In the paper, the committee said that banks that fail to meet CCB requirements “will be subject to automatic restrictions on the dividends and discretionary bonuses that they can pay out.”

In a sign of the enhanced powers it is seeking, the committee said its application of SCRs on mortgages will apply not just to loan books but also to “exposures held in the form of a securitization, a purchased portfolio, a fund or for trading.”

The FPC also said the powers will apply to loans made by U.K. banks in other countries. It said that had capital requirements been increased on U.K. lenders’ U.S. sub-prime mortgage lending before the financial crisis, “this would have left banks better able to absorb subsequent losses.”

The FPC said “no single set of indicators” can provide a perfect guide to systemic risks. “Judgment will therefore play a material role in all FPC decisions and policy will not mechanically tied to and specific set of indicators,” it said.

King said in November that banks may need to build up the capital they hold against potential losses, and asked regulators to report back by March on how lenders will comply. Banks may need to make bigger provisions for future loan losses and the cost of regulatory fines and customer redress. He said that risk-weightings may also be inappropriate.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE