LONDON (Reuters) - The Bank of England opened the way on Friday for Britain's banks to loosen their purse strings and tap the 500-billion pound cash pile they hold to boost stagnant economic growth.
The bank's Financial Policy Committee said banks had plenty of short-term cash set away for market shocks and could run these down, though they should still be prepared to forego paying as much in bonuses and dividends as in the past in order to build up longer-term capital buffers.
"If banks were willing to use these (cash) buffers, without reversing progress made to date in reducing reliance on short-term funding sources, this could support additional lending to the real economy," the FPC said in its biannual report on UK financial stability.
UK banks' holdings of highly liquid assets have tripled to more than 500 billion pounds since the end of 2008 to levels well beyond what regulators have asked for.
With Britain's economy mired in its second recession in four years, the Bank and the government also need many of these same banks to lend to businesses to spur growth and investment.
King has to strike a balancing act - and while much of a news conference on Friday was devoted to condemning some of these banks' culture, the key message from the BoE's supervisory Financial Policy Committee was that regulators should take steps to make it easier for these same banks to lend.
Two weeks ago the government and Bank announced plans to give banks cheap six-month loans - and potentially to further low-cost funding if the banks in turn lend more to business.
On Friday, the FPC said this meant banks have leeway to use tap their excess liquidity held in buffers, though they should still be prepared to forego paying as much in bonuses and dividends to build up longer-term capital buffers.
The money freed up for lending will run to billions of pounds.
Goldman Sachs - an investment bank which does not engage in much UK lending - said the announcement was an important element of a concerted policy easing by Britain and that even small tweaks to buffers could have quite material impacts.
The BoE's cheap funding programme could swell the banks' liquidity stockpiles by 160 billion pounds, making it easier for lenders to tap them, said Philip Rush, an analyst at Nomura.
"We welcome this proactive and less interventionist decision to reinterpret liquidity regulation. It may make banks more willing to extend loans insofar as they have room to hold less liquid assets on their balance sheets again," Rush said.
The Bank's director for financial stability, Andrew Haldane, said the Financial Services Authority will enact the FPC's recommendation over the next few weeks and that the money banks could release from liquidity buffers could be "chunky".
Banks have warned privately there is no guarantee freed up cash would end up in the pockets of credit-starved companies.
The assets held for liquidity purposes are mostly short-dated British government bonds. Banks built up these cash piles to avoid the fate of Northern Rock, which had to be nationalised after suffering Britain's first bank run in a century in 2007.
Liquidity buffers are separate from the capital cushions banks must hold and the FPC said lenders should still focus on building up the latter by curbing bonuses and dividends.
The FPC recommendations provide a rare note of regulatory relief for British banks in a week when Barclays was hit by a record fine for its part in an interest rates rigging scandal, and Royal Bank of Scotland could be next.
Britain's four biggest banks - HSBC, Lloyds, Barclays and RBS - were forced to pay compensation for misselling complex financial products to small businesses.
King accused banks of "shoddy treatment of customers" and "deceitful manipulation".
The euro zone remains the key worry for Britain's economy, he said. Since the FPC last met in March, Spain and Cyprus have had to ask for bailouts for their banks from other euro zone countries, pushing up funding costs for banks across Europe.
"The outlook for financial stability has deteriorated, particularly in light of heightened uncertainty about how and when euro area risks will be resolved," the FPC said.
The euro zone has been struggling for over to two years to find a long-term solution to dangerously high debt levels in some countries and banks.
Markets on Friday welcomed steps overnight by EU leaders to make it easier to inject capital into struggling banks and for the European Central Bank to supervise lenders in the single currency area - something King backed too.
"I personally would welcome having an opposite number at the ECB, with which we could talk about the capital and liquidity problems of major banks in Europe," King said.
The Bank takes over most British financial regulation next year, and the FPC's main role is to stop credit booms getting out of control and to monitor risks that cut a cross individual banks and threaten the financial system as a whole.
Reporting by Huw Jones and David Millien. Editing by Jeremy Gaunt.