Bank of England to make banks add £10bn buffer to cover consumer credit and warns on Brexit derivatives risk

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The Bank of England is tasked with protecting financial stability (Source: Getty)

The Bank of England today issued its strongest warning yet on the fast-expanding consumer credit sector, with financial stability experts at Threadneedle Street saying banks must hold another £10bn to cover potential losses.

Losses across the whole consumer credit sector could reach £30bn – £10bn higher than previous estimates – under the stress test scenario of sharply rising interest rates and unemployment, the Bank of England's financial policy committee (FPC) warned today.

The Bank also added it will closely scrutinise areas of the Brexit process which could harm financial stability, including the crucial functioning of derivatives contracts worth as much as £20 trillion.

While the FPC said there was no “material risk to economic growth” from the rising levels of lending, the Bank of England's Prudential Regulation Authority (PRA) will nevertheless make banks hold another £10bn in capital across the whole sector, under the so-called PRA buffer.

Read more: No let up in British consumer credit growth

That buffer will come in addition to the previously announced increase in the countercyclical buffer, which is set to come into effect next year. Each bank will be individually assessed by regulators, with Barclays and Lloyds expected to be among the banks hardest hit, owing to the size of their consumer lending portfolios.

The Bank of England has been concerned for some time now about double-digit growth in consumer credit, at a time when GDP growth has been markedly weaker.

Today, the FPC said: “Within a benign overall domestic credit environment, there is a pocket of risk in the rapid growth of consumer credit.”

The lending boom is particularly important for financial stability because of the much higher losses banks can suffer on unsecured consumer credit as opposed to the much larger, but secured, mortgage market.

The Bank today also fired a warning shot over financial stability concerns around Brexit, saying the process could endanger the functioning of 25 per cent of derivative positions for UK and EU clients – contracts worth an enormous £20 trillion in notional value.

Read more: Bank of England requires lenders to hold extra £11.4bn in capital

While individual contracts can theoretically be migrated easily from one jurisdiction to another in the case of reciprocal access between the EU and the UK falling through, the sheer scale of the migration required could make it impossible in the short time frames envisaged in a transitional deal.

The FPC said: “In areas where it would be complex and difficult for firms themselves to mitigate risks fully, such as the continuity of contracts between UK and EU 27 counterparties,the FPC is exploring other mitigating actions.”

Firms use derivatives contracts such as interest rate or currency swaps to hedge against risk. Any barriers to using these derivatives could impair firms' abilities to hedge, potentially making them more vulnerable to market movements.

Read more: Mortgage approvals jump to 16-month high, Bank of England figures show

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