RAISING capital requirements for bank lending will promote financial stability but will also increase the cost of credit and hit the economy in the short run, the Bank of England acknowledged yesterday.
Its policy document explaining how the Financial Policy Committee will try to identify and deal with financial bubbles also said the powers could put banks at a competitive disadvantage relative to other firms, particularly when operating abroad.
But the Bank hopes to coordinate action with foreign regulators, and believes in any case that the benefits of greater stability will outweigh those damaging side-effects.
The FPC will be able to raise capital requirements against bank lending if it fears a bubble building in a sector – such as mortgage or commercial property lending – or a country.
It can set limits on loan to value rates to discourage booms, or cap loan to income rates to make it harder for borrowers to over-extend themselves.
By forcing banks to hold more capital against a specific loan type, the FPC hopes to reduce the amount of credit available. But it knows this may also hurt growth.
“A one percentage point increase in capital requirements is estimated to lead to an increase in the interest rate on bank loans of between 4.5 and 25 basis points and a decline in the quantity of lending of between zero per cent and 3.6 per cent relative to baseline,” the Bank said.
It added studies have found “GDP will contract by between 0.05 per cent and 0.35 per cent relative to baseline in the short run following a 100 basis point increase in headline capital requirements.”