03 December 2013

BoE publishes Financial Stability Report

The Bank of England presented its biannual Financial Stability Report. The Financial Policy Committee said it would not consider imposing tougher balance sheet curbs on banks until global regulators have agreed a common definition.

Opening Remarks by the Governor

In the six months since the June Financial Stability Report an economic recovery has taken hold in the UK. Confidence has returned and credit conditions have eased further. UK banks have bolstered their capital positions by more than £20 billion to meet the shortfalls identified by the Financial Policy Committee (FPC) and Prudential Regulation Authority (PRA). Liquidity conditions remain robust.

To promote financial stability, the FPC’s job is not rest on these laurels but to focus on underlying and emerging vulnerabilities. Despite the return to solid growth, financial stability risks remain, including those arising from high levels of indebtedness both here and abroad. Sharp rises in global interest rates could test financial system resilience, particularly if not associated with strengthening incomes. In its risk assessment, the Committee paid particular attention to recent developments in the UK housing market. That reflects the importance of housing and mortgage debt on households’ and banks’ balance sheets. Risks to financial stability may grow if there are further substantial and rapid increases in house prices and a further build-up of household indebtedness. 

As part of a graduated response, the FPC is acting in concert with other authorities to implement a package of measures to guard against these risks. Some of these measures are already in train; others are new. Collectively, they are significant. But they are not exhaustive: in today’s FSR, the FPC outlines a wide range of additional steps that it could take in future, should they be necessary to meet its statutory objective to ensure financial stability. Authorities are announcing today two new measures. First, the PRA has decided to end its temporary capital relief on new household lending from the beginning of next year. Second, the Bank and HM Treasury have announced that the Funding for Lending Scheme (FLS) will be refocused towards supporting business lending starting next year. 

The package of measures is a coherent, proportionate response to the evolving risks in the housing market. Those risks are manageable and they are being managed. This will help keep the housing market on a sustainable path and ensure the broader economy continues to receive the stimulus it needs, for as long as it needs, to sustain the recovery. 

Securing financial stability requires much more than a resilient housing market. That is why the FPC has today set out in detail its three other strategic priorities for 2014. Those are: first, helping set the medium-term bank capital framework, including by conducting a review of the role of the leverage ratio within that framework; second, working to end ‘too big to fail’; and third, identifying and addressing risks in shadow banking, while supporting diverse and resilient sources of market-based finance. All of these structural measures are essential to developing a more resilient and diverse financial system."

Full remarks

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Excerpted from Executive Summary

Economic recovery in the United Kingdom, and in some other advanced economies, has strengthened and UK banks’ capital positions have improved. That has boosted confidence in financial stability, as evident in the Bank’s recent Systemic Risk Survey. But financial stability risks remain, including from the high indebtedness of some sovereigns, corporates and households. These vulnerabilities have been kept in check by low interest rates and other policy interventions. A sharp rise in interest rates, especially if not associated with a strengthening in incomes, could test financial system resilience. There are also signs of a deepening ‘search for yield’ in some markets, which could become a concern if they were to broaden and intensify into a more general mispricing of risk.

Full executive summary

Links to November 2013 Financial Stability Report

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Review of bank capital deferred until global agreement

In its June 2013 report, the Parliamentary Commission on Banking Standards (PCBS) had requested that the FPC provide its assessment of the appropriate leverage ratio and consider “whether the leverage ratio should be a regulatory front-stop rather than a back-stop given the recognised deficiencies in the risk-weighted assets approach to assessing capital adequacy”.

The Committee had noted in September that a full assessment would depend on the definition of leverage and that this was being negotiated internationally. Pending the completion of these negotiations, the Committee considered the main points to be included in a box on the leverage ratio in the November Financial Stability Report. The agreed main points were:

• The definition of the leverage ratio needed to be finalised before considering the appropriate calibration of its level.
• No single capital-adequacy metric could capture well all of the risks to balance sheets all of the time; as a result, the leverage ratio, the IRB risk-weighted approach and the capital ratio derived from the Basel standardised credit risk approach could be helpful complements to each other. The extent to which a leverage ratio or a risk-weighted capital requirement would bind depended on their respective calibration and on the types of risk to which banks and building societies were exposed. As such, the language of ‘frontstops’ and ‘backstops’ was potentially unhelpful.
• There would be merits in using time-varying changes in minimum leverage ratio requirements as a tool to help ensure financial stability.

With regard to calibration, the Committee discussed the potential merits of proportional changes in the leverage ratio and risk-weighted requirements to enhance the effectiveness of capital regulation in containing risks, including avoiding adverse incentives. It was noted that the Independent Commission on Banking (ICB) had recommended that ring-fenced banks should be subject to a higher risk-weighted minimum capital requirement (e.g. 10 per cent core equity tier one capital) and a proportionately higher leverage ratio requirement. This approach was intended to ensure that both metrics retained their respective roles in the regulatory framework and to ensure that appropriate assets were placed within the ring-fence. The Committee decided to return to these issues once an international agreement on the definition of the leverage ratio had been reached.

Full document

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