BoE trims banks capital requirements

July 6, 2016

The Bank of England has trimmed the capital requirements of commercial banks in its bi-annual Financial Stability report (FSR) published on Tuesday, in an attempt to waive off mounting Brexitrisks, post the June 23 UK referendum.The FSR also describes the current outlook for financial stability as 'challenging', adding that some Brexit risks have already started to crystallise.

The Bank of England (BoE) has cut the countercyclical capital buffer rate for UK banks with immediate effect to 0 percent, from 0.5 percent of financials’ UK exposure, the first bi-annual Financial Stability Report published by the BoE after the UK referendum showed Tuesday. This is turn, is expected to reduce the regulatory capital buffers by USD7.5 billion, which will raise the capacity to lend to households and businesses by about USD197 billion.

In the wake of rising Brexit risks, the report also warned that the nation’s highly leveraged real estate business will fall, which was mainly driven bypiling debts, should employment and growth in income decline in the months following UK’s exit from the European Union. The BoE had announced last week that it would extend its indexed long-term report operations on a weekly basis until the end of September 2016 to provide extra liquidity insurance to banks.

Moreover, the Bank of England governor, Mark Carney said in his speech that there are prospects of an economic slowdown in the British economy. Households are most susceptible to be hurt in the wake of a tougher economic outlook, he added. Further, the BoE expects the CCB to remain at 0 percent till 2017.

The 11-member committee also added that it is closely monitoring any key risks that would impede investor appetite for UK’s assets. Besides, it is also keeping a watch on the commercial real estate market, the vulnerability of indebted households and landlords, the global economic outlook and fragile liquidity in financial markets.

The countercyclical capital buffer was designed to be eased in a situation of downturn, in order to aide lending. Central bank officials also recommended that the Prudential Regulatory Authority, UK’s major bank regulator take in action a plan to reduce the supervisory capital buffers. But for all that the system has coped well so far, there are concerns that market liquidity could dry up and in the event that foreign investors begin to reassess their view of the UK, the challenges would be considerably greater.

The Financial Policy Committee is also watching the potential for buy-to-let investors to behave pro-cyclically and amplify movements in the housing market. Property is one of the key areas that analysts said would be impacted by the vote to leave. A Bloomberg index of house builders has slumped more than 30 percent since the referendum and Standard Life Investments suspended trading in its 2.9 billion-pound UK Real Estate fund on Monday.

"UK’s commercial real-estate transactions are particularly vulnerable to a change in investor preferences," the Financial Stability Report said.

Meanwhile, the report also mentioned that the current account deficit of the country, which stood at 32.6 billion pounds in the first quarter, or 6.9 percent of economic output is high by both historical as well as international standards.

However, to the extent that property is frequently used as loan collateral, reduced property valuations could deter corporate borrowing which would suggest some ripple effect across the wider economy. Outflows from REITs, which appear to have picked up following the referendum, threaten to depress the sector even more given that they represent around 7 percent of all investment in the UK commercial real estate market.

Lastly, the central bank governor also aimed at easing policy stance as it prepares to hold a monetary policy meeting on July 14. However, that would be a careful judgment taking into account any financial stability risks from too-low borrowing costs. Officials also encouraged the use of flexibility in Solvency II regulations in insurance companies to recalculate capital levels as they move between regulatory frameworks, so that they fail to rise as market interest rates fall.

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