The Bank of England has given the economy a £150 billion shot in the arm by relaxing financial regulations on lenders in its latest attempt to cushion the blow from the Brexit vote.
Banks will be able to burn through £5.7 billion of loss-absorbing capital after the decision to scrap the so-called counter-cyclical capital buffer, which was set to come into effect in March next year. The additional capital headroom will raise banks’ capacity for lending to UK households and businesses “by up to £150 billion”, the Bank said.
The measure was announced as the chancellor secured commitments from some of the country’s biggest lenders that they would use the capital to support the economy in the aftermath of Brexit. The heads of Barclays, Lloyds Banking Group, Royal Bank of Scotland, HSBC, Santander, Nationwide Building Society, Metro Bank and Virgin Money signed a joint statement that they would “make the extra capital available to support lending to UK businesses and households in this challenging time”.
Mark Carney, the governor, said that the Bank had decided to reverse its December decision to raise the buffer by 0.5 per cent because the environment was no longer benign, as he again warned about the dangers facing the economy. The buffer will be zero until at least June next year.
“Some of those risks have begun to crystallise,” he said, citing the withdrawal of foreign investors on which the UK had become reliant, the vulnerability of indebted households and possible losses in commercial property.
However, he emphasised that banks were in a strong position after years in which they had built up their loss- absorbing capital by £130 billion and had set aside £600 billion of liquidity to meet deposit withdrawals and help markets to function smoothly.
The banks’ efforts and authorities’ contingency measures should ensure that “the financial system dampens shocks rather than amplifies them”, Mr Carney said, in a reversal of Britain’s experience in the financial crisis.
Although lenders will have headroom for as much as £150 billion of new loans, they are unlikely to use it. The governor noted that only £60 billion was extended last year and he claimed demand was likely to be weaker now. “If we do see a slowing in credit growth, it will be demand-driven, not supply-driven,” he said.
As a condition of relaxing the rules, the regulator will not allow the banks to increase dividends or other shareholder distributions beyond that which has been discussed with supervisors, the Bank said.
Banks are likely to use the capital to absorb losses rather than increase lending. The average capital ratio of the big UK banks is 13.5 per cent, which means they have hit their 2019 requirements and are well ahead of European rivals.
Mr Carney said that the resilience of the UK financial system could be seen in the fact that “overall bank funding costs have not increased”. The collapse in bank share prices, which are down by more than a fifth since the June 23 vote, was “consistent with investor concerns over an uncertain economic outlook and lower bank profitability”, he said. “Markets are focused on returns, not concerned with resilience.”
The perceived strength of British banks is likely to keep mortgage rates low as stable funding costs “should reduce the pressure on banks to tighten credit conditions”, the Bank said in its Financial Stability Report. The observation will come as some relief for households.
Even so, banks could come under pressure from falling asset prices, particularly in commercial real estate, as foreign investors retreat from the UK.
Banks will be able to burn through £5.7 billion of loss-absorbing capital after the decision to scrap the so-called counter-cyclical capital buffer, which was due to come into effect in March next year.
The additional capital headroom will raise “banks’ capacity for lending to UK households and businesses by up to £150 billion”, the Bank said.
Its response to the destabilising impact of the UK’s decision to leave the European Union, came as the Bank warned that buy-to-let and commercial real estate lending posed real threats to growth.
It has already signalled that interest rate cuts are imminent and has extended a series of special weekly liquidity auctions until the end of September to keep banks flush with cash. Lenders have been provided with £250 billion of central bank liquidity should financial conditions get stressed.
Just under two weeks since the vote and negative outcomes are already evident. “There is evidence that some risks have begun to crystallise,” the Bank said in its twice-yearly Financial Stability Report.
The first signs of market instability emerged yesterday when Standard Life was forced to block investor withdrawals from a property fund after drawdown requests mushroomed. This morning sterling again lost ground in the currency markets, falling 1.8 per cent against the dollar taking it to $1.3113.
The Bank said today one of the biggest risks to financial stability was commercial real estate, which has been heavily supported by foreign investors. Since 2009, overseas money has been behind 45 per cent of transactions.
Britain’s changed economic prospects may make foreign investors reconsider, which could lead to losses that impact banks’ capital strength. The Bank also warned that buy-to-let landlords may start selling if mortgage costs rise, pushing down house prices.
“The behaviour of buy-to-let investors has the potential to amplify movements in the housing market,” the Bank said.
It also expressed concerns about “the high level of UK household indebtedness”. If unemployment rises and borrowing costs rise, some households could struggle to service their debts, the Bank said.
Relaxing capital rules will give banks more headroom to lend, but the Bank also expressed concerns about the smooth functioning of financial markets. To ensure lenders have the cash to meet deposit withdrawals and to provide market making facilities, the Bank said lenders should used their £600 billion of liquidity.
Regulations that require insurers to sell assets such as equities and corporate debt were relaxed to “smooth” their impact and prevent a mass sell-off of financial assets that could have destabilising market effects.
The Bank is expected to unveil a rate cut from 0.5 per cent to 0.25 per cent in the next week, when it may also announce a new credit easing scheme to ensure lenders can still make a profit in a zero-interest rate world.
The decision to relax the counter-cyclical capital buffer will reduce lenders’ capital requirements by 0.5 per cent. The capital position of the major UK banks is currently 13.5 per cent.
