(Dec 2): The Bank of England (BOE) cut its estimate of how much capital British banks need for the first time in a decade and signalled a consultation that could free up extra lending and higher payouts to shareholders, even as it flagged rising risks in private markets.
In a premarket announcement on Tuesday, the central bank said it now believes that the UK banking system should have Tier 1 capital equal (CET1) to around 13% of risk-weighted assets. The last estimate, which dates to 2015 and was affirmed in 2019, was 14%.
The reduction will take the form of a cut to a requirement known as Pillar 2A when the BOE implements the latest global capital reforms in 2027. The BOE’s Financial Policy Committee (FPC) also said it would be consulting on other enhancements to its capital framework next year.
“Given the reduction in the FPC’s benchmark, banks should have greater certainty and confidence in using their capital resources to lend to UK households and businesses,” the BOE said in a statement, as it noted the changes that had made the banking sector more resilient. Banks currently have an aggregate of around 17% of Tier 1 capital.
The capital revamp comes as the BOE confirmed that all seven of the UK’s top banks had passed this year’s stress test, demonstrating that they had enough capital to keep lending if the economy were hit by a severe stress that sent inflation and interest rates soaring. The last stress test failure was in 2016.
Still, the central bank’s quarterly financial stability update pointed to rising risks in some areas of finance, including artificial intelligence, where officials have escalated warnings about the risks of a multi-trillion dollar bubble unwinding, and government bonds markets, where hedge funds’ leveraged bets on gilts are drawing increasing scrutiny.
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In an 80-page document, the BOE detailed a range of topics up for consideration in its bank capital review, including:
- Reviewing the implementation of the leverage ratio, specifically the UK’s approach to regulatory buffers in leverage ratio requirements;
- Ways to make banks’ capital buffers more usable;
- The interaction between various capital buffers
The list of items to explore does not include changing the neutral level of the countercyclical buffer, a category of capital which banks can dip into to support lending during stress. Currently at 2%, banks say the UK’s level is out of sync with international markets.
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The BOE is instead focusing on improving the usability of buffers so that banks’ actual capital levels are closer to regulatory minimums.
“We will need to wait to see how banks react to whatever incentive functions the regulator utilises,” said Benjamin Toms, an analyst at RBC Europe, regarding the BOE’s efforts to make buffers more usable. “For banks already thinking about reducing their CET1 management targets, we do not see anything in this report which puts a spanner in the works.”
Lobbyists from UK Finance had urged the BOE to take a “bold and strategic” approach to the capital reset to preserve competitiveness as the US slashes rules for its banks and the EU weighs changes.
“The FPC and PRA are interested in the views of a broad range of stakeholders – including UK lenders, thinktanks, industry groups, investors, and academics – on the material covered in this paper, and welcome feedback and evidence on the issues identified for further assessment,” the BOE said in a statement. The Prudential Regulation Authority (PRA) is the BOE’s regulation arm.
The BOE also confirmed on Tuesday a new system-wide exploratory scenario, a form of a stress test, that will focus on private markets. This will explore how banks and other financial institutions active in private markets respond to a downturn in private asset valuations.
The initiative follows recent warnings from Bank of England governor Andrew Bailey about “alarm bells” ringing in the private finance sector, with platitudes offered by industry reminiscent of complacency over the quality of subprime debt before the financial crisis.
The monetary authority estimated that UK banks have £173 billion of banking book exposures to private market funds and corporates backed by financial sponsors, including private equity funds. While resilient to date, private markets have grown rapidly since the global financial crisis and have not been tested through a broad-based macroeconomic stress at its current size, the central bank said.
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“The data provided by banks this year has improved the level of insight into the interconnections between banks and private finance,” the BOE said in its report. “However, this remains a challenging area, where data remains limited on the underlying investors and assets on which bank lending to private market funds is secured.”
Meanwhile, the results of the traditional stress tests showed that “the UK banking system would be able to continue to support the economy even if economic conditions turn out materially worse than expected, enabling it to contribute to long-term sustainable economic growth,” the BOE said in its report.
Barclays plc, HSBC Holdings plc, Lloyds Banking Group plc, Nationwide Building Society, NatWest Group plc, Banco Santander SA’s British arm and Standard Chartered plc were tested this year. Together they account for around 75% of lending to the UK economy.
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