Bank of England Sees Countercyclical Buffer Rising on Risk

Updated on
  • BOE intends gradually to raise buffer to 1% as economy grows
  • Tool to be moved up or down in line with risk banks can incur

The Bank of England said it may begin forcing banks to set aside capital as soon as March to support lending in a downturn.

The BOE’s Financial Policy Committee intends gradually to increase the countercyclical-capital buffer to 1 percent, equivalent to about 10 billion pounds ($15.1 billion), as the U.K. economy recovers from the crisis and risks to stability re-emerge. Part of the capital is available in the buffers that supervisors require individual banks to set aside against specific risks and which will diminish as the countercyclical buffer is filled.

“The shift in financial conditions out of the post-crisis phase means that the FPC is now actively considering the appropriate setting of that buffer,” BOE Governor Mark Carney told reporters on Tuesday. “Domestic developments at present are consistent with the aggregate level of risk having increased.”

Carney cited the strength of the commercial and buy-to-let real-estate markets, as well as the elevated level of both household indebtedness and the current-account deficit ,as signs that risks to stability are increasing. While aggregate credit growth is “modest,” it’s rising and is close to the rate of growth in economic output, he said.

Officials published their thinking in London, alongside banking stress tests which all seven major British lenders passed.

Careful Review

The FPC left the countercyclical buffer rate at zero percent for domestic exposures on Tuesday, and set out its policy for using the flexible tool in the future. The central bank noted that financial conditions have shifted out of the post-crisis phase and said it will “carefully review” the rate at its next quarterly meeting.

As a first step in setting the buffer, supervisors will separate out risks currently covered by existing requirements and which will in future be captured by the countercyclical buffer, Carney said. The Prudential Regulation Authority will then carry out a one-time review of individual firms’ buffers in the first quarter of 2016 and it will raise the countercyclical buffer from zero without necessarily changing the overall capital charges for banks.

After that, “the FPC will carefully review the appropriate setting of the buffer rate in March,” Carney said.

The regulator “intends to vary the buffer -- both up and down -- in line with the risk at the system level that banks will incur,” the FPC said. It sees the buffer “in the region of 1 percent of risk-weighted assets when risks are judged to be neither subdued nor elevated.”

Boom Times

The countercyclical-capital buffer is intended to counteract banks’ tendency to boost lending in boom times, fueling the expansion, and slash it in the bust, exacerbating the slowdown. It’s designed to smooth peaks and troughs in lending by ensuring banks have the capital needed to support the economy in stressed periods because they have built it up when credit is growing.

An increase this month had been predicted by analysts at firms including Nomura International Plc and Morgan Stanley.

“By moving early, before risks are elevated, the FPC expects to be able to vary the countercyclical capital buffer gradually, and to reduce its economic cost,” the bank said.

The strategy for setting the buffer will be “to match the total equity buffer requirement of the banking system to the possible losses it could incur under stress,” it said.

As risks in the system become elevated, the FPC will raise the buffer rate beyond 1 percent, with no limit on how high it can go, the committee said. Under EU law and international agreements, “foreign authorities are mandated to reciprocate increases in the rate on U.K. exposures only up to 2.5 percent of risk-weighted U.K. exposures.”

The BOE issued its guidance on the buffer along with the stress-test results, the semi-annual Financial Stability Report and the findings of its Systemic Risk Survey.

— With assistance by Jennifer Ryan, Richard Partington, and Jillian Ward

(Adds comment from Carney in third paragraph.)
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