UK banks brace for £11.4bn capital demand from BOE

Bloomberg

The Bank of England (BOE) plans to increase capital requirements for UK lenders by 11.4 billion pounds ($14.5 billion) to tackle risks posed by consumer credit growth and prepare for the uncertain outcome of Brexit talks.
The BOE set the countercyclical capital buffer at 0.5 percent of risk-weighted assets for UK loans effective in June 2018. “Absent a material change in the outlook,” the central bank will increase the level again to 1 percent in November.
Each increase of 0.5 percent will swell banks’ cushion of common equity Tier 1, the highest-quality capital, by 5.7 billion pounds, according to the BOE’s Financial Stability Report published on Tuesday. The BOE also proposed boosting the leverage ratio to 3.25 percent of exposures excluding central-bank reserves.
This “measured approach is likely to decrease the risk that banks adjust by tightening credit conditions, thereby minimizing the cost to the economy of making the banking system more resilient,” the BOE said.
The countercyclical capital buffer is meant to guard against banks’ tendency to boost lending in boom times and slash it in a bust, potentially exacerbating a slowdown. The regulation is meant to ensure banks have enough capital to weather losses and continue making loans to support the economy.

‘Rapid Growth’
In the immediate aftermath of Britain’s vote to leave the EU last June, the BOE reversed a planned increase in the buffer to help stave off the U.K. slump that was predicted by economists. Since the referendum vote, the economy has performed better than expectations, leading BOE Governor Mark Carney to suggest the capital buffer could be increased.
The overall risks from UK exposures are at “neither particularly elevated nor subdued,” according to the BOE.
By the time the BOE considers raising the buffer rate to 1 percent, it will be able to factor in the results of its 2017 stress test of major U.K. banks. Because of the “rapid growth” in consumer credit in the last 12 months, the BOE will bring forward an assessment of stressed losses on this lending to inform its November decision on the buffer.
The BOE previously said raising the buffer is likely to tighten credit, with bank lending spreads increasing by about 10 basis points in response to a 1 percent buffer level in a “stable” economic environment.
The increase of the minimum leverage ratio requirement to 3.25 percent from 3 percent is intended to restore the “level of resilience” delivered before the FPC decision to exclude central-bank reserves from the measure, the BOE said.

Stress Test
The FPC also tightened standards for mortgage lending, requiring banks to stress test borrowers’ ability to repay loans at three percentage points above the standard variable rate.
The BOE said asset valuations on some corporate bonds and U.K. commercial real estate “appear to factor in a low level of long-term market interest rates, but do not appear to be consistent with the pessimistic and uncertain outlook embodied in those rates.”
On Brexit, the BOE said it will oversee banks’ contingency planning for a “range of possible outcomes” of the talks on the U.K. withdrawal from the European Union.
“Fragmentation of market-based finance could result in higher costs and greater risks for both EU and U.K. companies and households,” the BOE said. A single basis-point cost increase resulting from splitting clearing of interest-rate swaps currently focused in London could cost EU firms 22 billion euros a year, the BOE said, citing industry
estimates.
Among wider risks to the UK financial system, the BOE pointed to China, where “capital outflows have stabilized, but economic growth continues to be accompanied by rapid credit expansion.”