LONDON (Reuters) - Britain’s banks face growing risks from the euro zone debt crisis but may need to run down capital levels to keep credit flowing rather than building up additional buffers to deal with losses, the Bank of England said on Wednesday.
The Financial Policy Committee’s line runs counter to a debate in Europe, which is focussed rather on how much extra capital would be needed to help banks ride out the impact of Greece and potentially other euro zone members defaulting.
Britain’s banks already have among the highest levels of core capital in the world at well over 10 percent.
The FPC — set up on an interim basis pending approval of a draft law — also called for powers to intervene over bank balance sheets, the terms of market transactions, and trading systems, to help identify and tackle potential financial crises.
The committee said that since its last meeting in June, there had been severe strains due to the euro zone debt crisis.
“Anxiety about the consequences of these issues for banks had increased materially and, in turn, the perceived vulnerabilities of banks were adding to strains in financial markets,” it said.
In recent weeks markets have become more convinced that Greece will default on its debt, triggering big sell-offs of shares in European banks which hold the country’s sovereign bonds.
The statement echoed similar concerns last week from the EU’s European Systemic Risk Board, whose vice-chairman is Bank of England Governor and FPC chairman Mervyn King.
Unsustainable debt positions of euro area countries would need long-term reforms, but “given the scale of the current risks” short-term action was needed to keep credit flowing from banks to the economy, the FPC said.
In June the FPC recommended that banks beef up capital levels, but in Wednesday’s statement it said that some actions to raise capital or liquidity “could potentially worsen the feedback loop between the financial sector and the wider economy and so should be avoided.”
Britain’s financial services regulator has so far been amongst the toughest in forcing banks to run high capital buffers, and the FPC’s statement points to concern that may have a negative impact on growth.
The FPC also said that “in the event that severe risks crystallised, it would be natural for banks’ capital and liquidity ratio to be run down to ensure that lending to the non-financial economy was not impaired.”
Nomura bank said the FPC now sounded “much more accommodative” as the committee noted progress made by banks so far in building up their capital and liquidity buffers.
“We welcome this flexibility as something that is essential to damping down the credit cycle. Ultimately, buffers are there to be used,” Nomura said in a note to clients.
The committee said banks should still strengthen their buffers, such as by cutting back on discretionary distributions, as long as they don’t crimp the economy.
The interim FPC held its first meeting in June, and meets quarterly to advise British authorities on financial regulatory issues.
The government intends to give it formal regulatory powers by early 2013 and in Wednesday’s statement the committee outlined what sort of tools it wants to intervene and curb emerging asset bubbles that threaten to destabilise markets.
It said it wants “directive” powers to order firms to make changes in three key areas:
— balance sheets of banks and other financial institutions;
— the terms and conditions of transactions in particular financial markets;
— market structures, a reference to exchanges and clearing houses.
The FPC said it needs to debate further the actual tools used to intervene in the three areas but suggested they could include telling banks to increase capital and liquidity buffers and capping loan to value ratios in mortgages.
Other tools could include forcing transactions on to exchanges and clearing houses to make them safer and more transparent.
“With the creation of the FPC, and its power to direct the FSA in its supervisory duties, the Bank of England now has a vehicle for more direct intervention in credit markets, taking some of the pressure off monetary policy for controlling the credit cycle,” Barclays Capital said in a note.
The committee envisages a narrow set of tools at first, later expanding them as it sees new risks evolving.
The Bank reiterated the need for a draft European Union law on stronger bank capital standards to allow individual member states to require bigger buffers at domestic banks to ensure financial stability.
Editing by Jon Loades-Carter