City welcomes relaxing of banking rules

THE CITY reacted positively to the Financial Services Authority (FSA)’s easing of banking rules yesterday, sending shares in Britain’s major banks up, although experts warned that the moves could prove risky.

The FSA has been relaxing rules on capital and liquidity in recent months to encourage banks to lend. Banks are now set a fixed level of capital to keep in reserve, as opposed to 10 per cent of lending, and do not have to hold funds against loans under the Funding for Lending Scheme. The new regulations were described as a “rebalancing” by the FSA on Tuesday night, after fears that banks were neglecting to lend money due to strict rules.

British bank stocks rose in trading yesterday, defying a general downturn in the sector. Lloyds was the biggest riser of the day, climbing 3.4 per cent, while RBS gained 2.4 per cent. HSBC and Barclays also beat a 0.2 per cent fall in the European banking index and a downturn in the FTSE 100. However, analysts warned the changes could increase risk in the industry, with banks less strict on who they lend to.

“The incentives of banks to screen loan quality could decrease significantly if banks expect the FSA to relax capital requirements during recessions but leave them intact during booms. Lending may increase, but at the expense of higher default probabilities, and more severe recessions in the future,” Enrique Schroth of Cass Business School said.

“Banks will naturally start making forecasts of the FSA’s reactions, and the FSA will have to develop a reputation of sticking to rules set in stone or acting discretionally,” he added.

The FSA denied that the new regulations would lead to more risk in the system, saying the changes had been designed to keep the banks “resilient”, yet “provide them with resources so that they can lend”.

Chirantan Barua, an analyst at Bernstein Research, said: “If they get a bit of leeway from the regulator, that's breathing space for these banks, which in the short term is good for the shares. Longer term I stay very cautious.”

The shift to a fixed amount of capital from a capital ratio chimes with a move by the European Union's banking regulator last week. The European Banking Authority said EU banks, which had been required to hold capital of nine per cent of their risk-weighted assets, will in future be told to hold a set amount.