The Bank of England has issued a stark warning on the financial outlook for the UK and global markets, but told financial institutions that it would be “counterproductive” to shore up their balance sheets by withholding new loans.
The warning on Tuesday, contained in the BoE’s quarterly financial stability update, comes as the UK faces its highest inflation rates in 40 years, adding to concerns that households and businesses will struggle to pay their debts.
“Since the last financial stability report, the global economic outlook has deteriorated markedly,” said Andrew Bailey, the BoE’s governor. “Developments in the Russian invasion of Ukraine have been a key factor affecting the global outlook.”
The BoE also noted the recent turmoil in global markets and cautioned that “risky asset prices remain vulnerable to further sharp adjustments” against a backdrop of additional supply shocks, faster than expected increases in global interest rates and slower than expected economic growth.
Capital ratios of UK banks — effectively a measure of the war chests from which they can grant loans and absorb losses — have already begun falling “in line with expectations” and there were “tentative signs” that banks were “reducing their risk-taking at the margins”, the central bank said. It also noted that financial institutions had “considerable capacity” to continue lending, even in a deteriorating environment.
“Restricting lending solely to defend capital ratios or capital buffers would be counterproductive and could prevent creditworthy businesses and households from accessing funding,” said the BoE. “Such excessive tightening would harm the broader economy and ultimately the banks themselves.”
The central bank also announced that the buffer banks are required to build up and then release during a crisis must be increased to 2 per cent by July 2023. It added that it would begin work on the next set of stress tests, which assess individual banks’ ability to withstand future crises, in September. The exercise will include “deep simultaneous recession in the UK and global economies, real income shocks, large falls in asset prices and higher global interest rates”. There will also be a separate stress test of misconduct costs.
Bailey said the BoE would support a review of “ultra long” mortgages of up to 50 years, which could stretch across generations. UK prime minister Boris Johnson last week told reporters that the government was looking into the idea.
Longer-term mortgages would protect customers from fluctuations in interest rates far better than the relatively short-term fixed mortgages that are prevalent in the UK. Forty per cent of which are set to expire in 2022 or 2023.
The BoE report also noted that while the extreme volatility in cryptocurrencies does not yet pose a risk to overall financial stability, systemic risks would emerge if regulation was not put in place.
The market capitalisation of digital assets has collapsed from a peak of $3tn in November to less than $1tn, as the failures of the interlinked cryptocurrencies Terra and Luna caused ripples through the wider sector.
“I think for me [the collapse] underlines the fact that we now need to bring in a regulatory system that manages the risks in the crypto world,” said Sir Jon Cunliffe, the BoE’s deputy governor for financial stability. “I wouldn’t take the lesson that we don’t have to do anything because [the problem] has gone away.”
Source: Economy - ft.com
