In addition to the previously noted fireworks from Mario Draghi, also on Tuesday the Bank of England ordered banks to build greater capital cushions in the coming months to protect the U.K. financial system from risks ranging from Brexit to China to booming consumer borrowing. In its twice-annual financial stability report, the BOE's Financial Policy Committee said that there are “pockets of risk” in the financial system, and to address them the BOE set the countercyclical capital buffer at 0.5% of risk-weighted assets for U.K. loans effective in June 2018, and if nothing material changes the central bank plans to increase the level again to 1% in November.
Each increase of 0.5 percent will swell banks’ cushion of common equity Tier 1, the highest-quality capital, by 5.7 billion pounds, according to the BOE’s Financial Stability Report. The BOE opted for a staggered approach because it’s less likely to result in banks tightening lending in response.
Additionally, next month regulators will publish new guidelines for consumer lending to ensure risks are priced and managed appropriately.
“We want to move the levels of capital back up to the level they should be -- any time you move into more benign credit conditions there have been fewer defaults,” which can lead to complacency, Governor Mark Carney said on Tuesday. Regarding Brexit, “there are risks around that process, so contingency planning needs to be not only put in place but also activated.”
The BOE laid out several risks facing the financial system, starting with the domestic front, where the central bank said unsecured consumer borrowing in Britain is growing rapidly and lending standards in the mortgage market appear to be deteriorating, raising the risk that banks could face losses if the economy weakens. As expected, the BOE highlighted risks surrounding the U.K.’s exit from the European Union. The BOE said it is overseeing the financial system’s contingency planning for withdrawal—including the possibility the U.K. crashes out of the EU without a deal on the terms of its divorce or future economic ties when a two-year window for talks closes.
“We start from the most difficult situation from a financial stability perspective,” said BOE Gov. Mark Carney, explaining that while a “no deal” scenario might not be the most likely outcome, it would be the most threatening.
Officials said they are also monitoring potential threats from overseas. The risk to the global financial system from ballooning debts in China remains “pronounced,” the committee said.
And, as noted above, in response to these risks, which the BOE described as “standard” rather than elevated, the central bank said it raised banks’ so-called countercyclical capital buffer to 0.5% from its current level of zero and expects to raise it again, to 1%, in November. In total, the capital requirements for U.K. lenders will rise by 11.4 billion pounds ($14.5 billion).
The BOE move follows months of concern about unsecured consumer borrowing in the U.K., which is currently growing at an annual rate in excess of 10% as consumers turn to debt to support their spending amid meager wage growth and higher inflation.
As the WSJ notes, officials said they want banks to perform stricter tests on borrowers to ensure they can afford repayments. However, they stressed that household borrowing was growing at the same rate as the economy, and didn’t appear to be motivated by excessive risk taking.
“I wouldn’t characterize the behavior of U.K. households as a whole as taking particularly elevated risks,” Mr. Carney said.
By contrast with the BOE, the Central Bank of Ireland Tuesday said it would leave its countercyclical capital buffer at zero, citing the fact that lending to businesses and households continues to decline.
The BOE’s Monetary Policy Committee held the central bank’s benchmark interest rate at 0.25% when it met earlier this month, but there are signs of growing dissent with the policy. Chief Economist Andy Haldane said in a speech last week that he may soon push for a rise in borrowing costs to restrain rising inflation.
As the WSJ adds, Carney and other senior officials sit on both the MPC and the FPC and have a variety of other roles. In her valedictory speech last week, departing MPC member Kristin Forbes said that spread of responsibilities had given officials less time to develop their own views on monetary policy, and in particular understand the need for a rise in interest rates.
However, Carney dismissed that criticism. “It takes as much time to decide to hold interest rates as it does to raise interest rates,” he said. “I can assure you we devote the necessary time to making monetary policy decisions.”