UK banks need a lot more capital according to the Bank of England

Bank of England warns UK banks need more capital

Britain’s banks do not have enough capital to withstand an escalation in the eurozone crisis, the Bank of England has warned.

By Philip Aldrick, Economics Editor
4:00PM BST 06 Jul 2012

Members of the Financial Policy Committee (FPC), the Bank’s risk regulator, “judged that the overall capitalisation of the banking system was unlikely to be sufficient for stability to be assured” if there were “severe but plausible” developments in the sovereign debt crisis, according to minutes of last month’s meeting.

The committee was also sufficiently concerned about weak lending in the UK to consider suspending the rules governing how much banks must hold in cash and other liquid assets to get credit flowing again. The rules may have “pushed up the pricing of loans” and, by relaxing them, funds “supporting liquid assets could potentially be used instead to finance lending”, the minutes said.

Both issues were addressed in last week’s Financial Stability Report, when banks were told to continue building up their capital levels and liquidity regulations were relaxed slightly instead of suspended. Analysis of the report showed that easing the liquidity rules could release as much as £150bn for lending to small businesses and households.

Banks had been hoping for the capital rules to be loosened as well, but the FPC decided the risks to financial stability and the economy were too great, even though UK lenders are “reasonably well placed” to meet new standards that begin coming into effect next year.

“The committee was concerned that in especially severe, but plausible, adverse scenarios in the euro area some UK banks could face large losses,” the FPC said. Although “the position of individual institutions varied significantly”, the overall health of the banks was too weak and threatened “the supply of financial services to the economy”.

Barclays is the most exposed of all UK lenders to the eurozone periphery, with loan and sovereign debt exposures equivalent to 170pc of its entire equity capital. Royal Bank of Scotland also has dangerously large total exposures to the region.

Banks have increased their capital levels by £90bn since the crisis but they have been broadly flat since last year. To boost their capital, the FPC said banks now need to issue equity or contingent capital because “the weak profit outlook for banks would make it difficult to raise sufficient additional capital solely by limiting cash dividends and compensation”. Debt-for-equity swaps should also be considered, it said, which could raise £8bn.

Some of the extra capital could also be used to “support lending immediately” but the bulk would be to “enhance market perceptions of resilience and reduce funding costs”.

The Bank has been taking drastic measures to rekindle growth in the UK. Last month, it unveiled a “funding for lending” scheme to boost the supply of credit to businesses and families and lower borrowing costs, as well as an emergency liquidity facility to underpin confidence in the banks.

It has since loosened the liquidity rules and injected another £50bn of stimulus into the economy through quantitative easing, which is now due to hit £375bn or almost 40pc of the entire stock of national debt. The Bank has grown particularly concerned that rising borrowing costs could trigger defaults that cause bank losses to mount, setting off “an adverse feedback loop” that would “weigh on economic growth and threaten the health of the financial system as a whole”.

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