BOE Sees Challenging Outlook for U.K. Banks on Emerging Markets

  • Greece risk has eased; China, fine concerns increase, BOE says
  • Countercyclical buffer rate held at 0% as CET1 ratios near 12%

The Bank of England said the U.K. financial-stability outlook “remains challenging” as increasing risks to the system from emerging markets offset its improved resilience.

“The immediate risks in relation to Greece and the euro area have fallen somewhat from their acute level” in July, the BOE’s Financial Policy Committee said in a report Friday. “However, other downside risks to U.K. financial stability stemming from the global environment, and to which the United Kingdom as a global financial center is exposed, have increased. These risks come from both China and emerging market economies more broadly.”

Mitigating those risks, the FPC said that major U.K. banks’ core equity Tier 1 capital ratios, a measure of resilience, have risen by 1.1 percentage points in the past year to 11.9 percent, and funding spreads “rose only a little in response to market volatility in recent months.” As a result, the FPC kept the countercyclical capital buffer rate for U.K. exposures, applied to banks if needed, at zero percent. The regulator will review the rate after BOE stress-test results are announced in the fourth quarter.

Regulators are seeking to broaden their view of the financial system after the crisis showed how risks can build unseen, creating feedback loops and contagion that can cause seemingly solid institutions to collapse. They are turning their attention to potential crises outside the banking system in institutions such as insurers and asset managers, and examining economic scenarios that may cause banks to lower their guard when making lending decisions.

The BOE may consider using stress tests of differing severity to assess the resilience of the financial system as economic booms turn to busts, Deputy Governor Jon Cunliffe said in July.

The FPC identified other “potential headwinds” to banks’ resilience in the report, including fines. 

“The scale of future misconduct and redress costs for the U.K. banking sector is highly uncertain and banks should hold sufficient resources to pay these costs without affecting their ability to continue to lend to the real economy,” the regulator said. Potential future costs will be reviewed as part of the 2015 stress test, it said.

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