BOE Says Market May Be Underpricing Risks of Falling Liquidity

  • Says buy-to-let housing growth shows need for official powers
  • Will assess appropriate CCB level given credit improvements

Financial markets may not be alert to the potential damage caused by drops in liquidity, according to stability officials at the Bank of England.

“Market prices might not yet sufficiently be factoring in the potential for a deterioration in liquidity conditions given changes in market functioning and elevated tail risks” related to emerging markets, the officials said, according to the record of the Financial Policy Committee meeting held on Sept. 23 in London.

Concern about liquidity is intensifying since a global bond rout in the second quarter erased more than a half a trillion dollars in the value of sovereign debt. Exacerbating matters, the world’s biggest banks are scaling back their bond-trading activities to comply with higher capital requirements imposed in the wake of the financial crisis.

Stability officials at the BOE have already asked for more work to be done on the topic, including dealers’ ability to act as intermediaries in markets, contagion and investment funds.

The record of the September meeting published Thursday also noted the increased importance of emerging markets and said “there was the potential for a material impact on U.K. financial stability.”

Credit Conditions

Officials also discussed the appropriate settings for the countercyclical capital buffer, currently at zero, given that credit conditions were normalizing. When officials reconsider the setting in light of the 2015 stress-test results, they will assess the appropriate level for all stages of the credit cycle.

There was a “possible benefit of moving the CCB in smaller increments, especially when credit growth was not unusually strong,” the record said.

In a wide-ranging record that follows last week’s statement, the FPC highlighted its need for new powers to intervene in the buy-to-let housing market.

“The rapid growth of the market underscored the importance of FPC powers of direction for use in future,” the FPC said in its record. “Housing tools were important for the FPC,” given the potential for systemic risks.

Greece Assessment

The reduction of risks from Greece prompted officials to publish their assessments of that situation, that they’d made in March and June. They’d declined to include these in meeting records and statements published at the time as they judged that “would be against the public interest.” The bank had previously exercised this power of delay with comments on the Scottish referendum on independence last year.

“Renewed or increased stress in the euro area and associated market uncertainty could lead to an increase in interbank funding costs,” the FPC said in March.

Since strains in the euro area emerged in 2010-2012, banks’ capital and liquidity positions had improved and BOE had expanded its ability to provide liquidity insurance, the BOE said in March. This meant the central bank was able to “respond quickly if a liquidity need arose.” The FPC also declined to publish these comments in June, saying “there was a risk of exacerbating the risks that the contingency planning was seeking to mitigate.”

A separate release Thursday showed the FPC will meet on March 23, June 28, September 20 and November 23 in 2016. Financial Stability Reports will be published on July 5 and November 30.

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