Bank of England requires banks to hold extra £11.4bn in capital as it warns of pockets of risk in the UK economy

Jasper Jolly
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Bank Of England Hold Press Conference On The Financial Stability Report
Mark Carney chairs the Financial Policy Committee (Source: Getty)

The Bank of England has raised its requirements for the amount of cash British banks have to hold as it looks to build up capital buffers against a financial system shock.

Presenting the biannual Financial Stability Report, governor Mark Carney warned of growing “pockets of risk that warrant extra vigiliance” in the UK economy that could threaten the financial system.

Some lenders are not doing enough to prepare for a crisis, and are in danger of "forgetting the lessons of the past" by lowering underwriting standards, Carney warned.

A bigger buffer

British banks will be forced to hold another £11.4bn within 18 months as the countercyclical capital buffer rises first to 0.5 per cent of bank assets and then to one per cent in November.

Banks will have a year to build the initial £5.7bn buffer announced today, and 18 months for the second slice, barring any shocks to the economy. Carney added that he expects most banks to already have enough capital to fulfil the heightened requirements.

The countercyclical capital buffer first came into effect in March 2016, but it was lowered to zero per cent in the aftermath of the Brexit vote last year as the Bank predicted a sharp hit to the UK economy and a possible tightening of the supply of credit.

Since then the economy has performed more strongly than the Bank predicted, with it now judging it can raise capital requirements to prepare for the next shock.

Pockets of risk

Risks to UK financial stability have been downgraded from "elevated" to a “standard level”, according to the Financial Policy Committee (FPC), the Bank of England body responsible for monitoring the resilience of the financial system.

However, the Bank has its eye on lending to consumers, which has undergone a boom in the last few years to reach £198bn in April. Although consumer credit only accounts for 10 per cent of lending to UK borrowers, it is responsible for a far higher proportion of banking sector losses.

Banks may be basing their calculations on the expectation the current benign environment will continue indefinitely, rather than preparing for the worst, the FPC said.

Meanwhile the FPC has acted to tighten the affordability tests on mortgages. Lenders will now have to ensure their customers can afford a rise in interest rates they pay to around seven per cent.

Some complacency may also be extending into asset prices: corporate bonds may be overpriced, while commercial real estate prices are stretching the limits of sustainable valuations, the FPC said.

Aggregate commercial property prices are at the very top end of the range the Bank thinks is sustainable. However, in a worrying sign for the London property market the Bank warned West End office prices have been stretched far above levels that can last in the longer term.

There could be an "abrupt" readjustment in commercial property prices, Carney warned.

Brexit planning

The Bank’s economists will also be busy testing the effects on financial stability of Brexit, with a “no deal” scenario among the most important.

The FPC said it is drawing up contingency plans for a potential direct disruption to financial services if the UK fails to reach a deal with the EU. Meanwhile, the Bank said it will also consider the effects of a possible macroeconomic shock through its stress tests.

The Bank said: “The FPC is aiming to promote an orderly adjustment to the new relationship between the United Kingdom and the European Union.”

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