Bank of England Urges Banks To Increase Capital

Banks need to raise new capital as soon as they can, because the global financial system remains fragile despite action by the European Central Bank to shore up the euro zone, the Bank of England’s new risk watchdog said on Friday.
The Bank’s Financial Policy Committee (FPC) said banks had gone as far as they could to raise capital by keeping down pay and dividends, and called on the government to give it powers to force banks to raise capital if they resisted.
But the FPC stopped short of asking for the right to intervene directly in the market for home loans, wary of sparking a political backlash if it made house purchases harder.

From next year the body will become Britain’s top financial supervisor, as part of a far-reaching change to British bank regulation in the wake of the financial crisis. It is one of a new breed of watchdogs springing up across the world to spot risks that go beyond a single bank, plugging a gap in previous supervision that focused on misconduct by individual lenders.

The FPC – echoing previous comments from the central bank – said financial market tensions had eased after the European Central Bank pumped a trillion euros into European banks since the FPC’s last meeting in December.
This has helped British banks to raise long-term debt finance and revived their share prices by one third, and it was now cheaper to insure against them failing to pay back their debts.

“The committee agreed, however, that conditions remained fragile,” the Bank said. “Questions remained about the indebtedness and competitiveness of some European countries. Banks with large exposures to those countries … should be particularly alert to the need to build capital,” it said.
Previously, the FPC had advised banks to increase their capital buffers against future shocks on an opportunistic basis, in part by keeping down pay and dividend payments. But this approach had gone as far as it could, and banks now needed to take more resolute action as early as was feasible.
The British Bankers’ Association said calls for higher capital needed to be balanced against the need to help economic growth and that UK lenders have “already restructured and raised additional capital and are well on the way to meeting Basel III requirements”. HSBC (HSBA.L), Barclays (BARC.L), Lloyds (LLOY.L) and RBS (RBS.L) already hold core capital levels of about 10 percent or more, well above the 7 percent minimum set by Basel III, the international accord on safety buffers for banks.
Currently the FPC only has powers to recommend banks take action, but from next year it will be able to give them orders. Britain’s finance ministry had asked the FPC to set out the powers it wants, and on Friday it set out three – a smaller initial number than some analysts had expected.
Most strikingly, it said it would be premature to have the power to set minimum income or deposit requirements for borrowers in Britain’s mortgage market.

The committee said it “did not perceive the public debate necessary to achieve acceptability for such instruments to be sufficiently advanced at present” and industry analysts said the FPC appeared keen not to overplay its hand.
“The fact they have not been quite as greedy for powers as one might expect is probably connected to reservations shown by parliament’s Treasury Select Committee, where there was clearly uneasiness about the extent to which FPC powers might infringe on the political domain,” said Michael McKee, a partner at law firm DLA Piper, Reuters reported.

However, the FPC will still have powers to intervene in the mortgage market indirectly. It could recommend that other regulators look more closely at lenders it believed were acting imprudently, and also called for powers to raise capital requirements on lending categories it believes are more risky – potentially including high loan-to-value mortgages.
These so-called ‘sectoral capital requirements’ potentially give the Bank wide-reaching powers to shape the flow of lending around the British economy, giving incentives to areas it believes are desirable – for example, business lending – while restricting credit elsewhere, like in commercial real estate.

The FPC also wants to be able to vary the limit on banks’ leverage ratio – the maximum multiple of assets that they are able to lend – and employ ‘counter-cyclical capital buffers’.
By raising capital requirements across the board in a boom, the FPC would in theory discourage risky lending, and leave banks more protected when a bubble burst. Conversely, these fatter capital buffers built up in a boom could be drawn down on in a slump to get credit growing faster.
UK finance minister George Osborne said the FPC’s work puts Britain “at the forefront” of financial regulation and the committee’s proposals would now go to a public consultation.