Fears Bank of England does not know how new powers work

Tim Wallace
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CENTRAL bankers must be cautious when steering the economy by fine-tuning the levels of capital held by banks against specific loan types, a report from Bank of England researchers has warned.

The Bank is gaining powers to tweak capital levels held against various types of loan, allowing it to stop bubbles growing in sectors like commercial property.

Policymakers will aim to hike capital requirements in boom years to stop the economy overheating, and cut them in bad years to allow more lending and growth.

But such a policy has not been tried before, meaning there is little evidence on how it might turn out.

“There is considerable uncertainty over how these theoretical channels operate in practice. Unlike monetary policy, we lack a track record on the effects of varying macroprudential tools,” said the report.

“The literature on the impact of macroprudential policy is growing but remains fragmented, and there are several important gaps in our understanding of how it might operate.”

Central banks must also strive to understand exactly how its policies and actions change expectations of banks and of investors.

For example the report argues clearing up any uncertainty over how the Bank of England measures capital levels and capital quality is vital to inject more certainty into the sector.

“This could help lower sound banks’ funding costs through the signalling channel while forcing weaker banks to recapitalise in order to meet the standards, thus underpinning sustained recovery in credit growth,” it said.