BoE financial stability report identifies near term risks and long term recommendations

The Bank of England has said that banks would be vulnerable to an abrupt increase in interest rates or a widening of credit spreads in the near term in its biannual Financial Stability Report, released today.

For much of the period since the previous report, prices of risky assets rose and balance sheets across the financial system strengthened. More recently, however, asset prices have fallen and financial markets have been volatile, reflecting shifting expectations of the path of monetary policy in some of the major advanced economies. The outlook for financial stability is still clouded by risks from a weak and uneven global recovery, and imbalances in the euro area.

The bank made a number of policy recommendations to the Prudential Regulation Authority and – for the first time – the Financial Conduct Authority.

First off, the FCA and the PRA should provide an assessment to the FPC of the vulnerability of borrowers and financial institutions to sharp upward movements in long-term interest rates and credit spreads in the current low interest rate environment, as this is something that's not yet fully understood. The report will be due in September 2013.

Further, when assessing the liquidity of banks and building societies, the PRA should use (among other measures) the liquidity coverage ratio (LCR) as defined in the EU implementation of the Basel standard.

Speaking at a press conference, Paul Tucker said that the minimum requirement should be set at an LCR of 80 per cent until January 2015 (versus the 60 per cent EU requirement by this deadline), rising to 100 per cent by January 2018. He said this struck the right balance between supporting economic recovery without compromising financial stability.

Meanwhile, not all risks to stability are financial. In particular, cyber attacks are a particular threat that needs addressing, said Tucker, and the public and private sector will need to work together to prevent and mitigate future attacks.

Other key recommendations include:

  • The PRA should continue to work with the banking industry to ensure greater consistency and comparability of the Pillar 3 disclosures of the major UK banks and building societies, including reconciliation of accounting and regulatory measures of capital.
  • The PRA should ensure that all major UK banks and building societies comply fully with the October 2012 recommendations of the Enhanced Disclosure Task Force (EDTF) upon publication of their 2013 annual reports.
  • The PRA should assess the feasibility of the major UK banks and building societies calculating their regulatory capital ratios under end-point Basel III definitions using the standardised approach to credit risk. The PRA should report back to the FPC for its 2013 Q4 meeting.

Comments on the press conference (being streamed here):