The Bank of England issued a stark warning about the financial outlook for UK and global markets, but told financial institutions it would be “counterproductive” to shore up their balance sheets by withholding new loans.
Tuesday’s warning, contained in the BoE’s quarterly financial stability update, comes as the UK faces its highest inflation rate in 40 years, fueling fears that households and businesses will struggle to pay down debt you are
“Since the last Financial Stability Report, the global economic outlook has deteriorated significantly,” said Andrew Bailey, governor of the BoE. “The development of the Russian incursion into Ukraine was a key factor influencing the global outlook.”
The BoE also noted the recent turmoil in global markets and warned that “risk asset prices remain vulnerable to further sharp corrections” amid further supply shocks, a faster-than-expected rise in global interest rates and a slower-than-expected expected economic growth.
UK banks’ capital ratios — effectively a measure of the military assets they can lend and absorb losses — had already started to fall “in line with expectations” and there were “preliminary signs” that banks were “reducing their underwriting margin risk,” the central bank said. He also noted that financial institutions have “significant capacity” to continue lending, even in a deteriorating environment.
“Restricting lending solely to protect capital ratios or capital buffers would be counterproductive and could prevent creditworthy businesses and households from accessing finance,” the BoE said. “Such excessive tightening would hurt the economy as a whole and ultimately the banks themselves.”
The central bank also announced that the buffer banks are required to build up and then release in times of crisis should be increased to 2 percent by July 2023. It added that it would begin work on the next set of stressors tests that assess individual banks’ ability to withstand future crises, in September. The exercise will involve “a deep simultaneous recession in the UK and global economies, real income shocks, large falls in asset prices and higher global interest rates”. There will also be a separate stress test of misconduct costs.
Bailey said the BoE would support a review of “ultra-long” mortgages of up to 50 years, which can span generations. UK Prime Minister Boris Johnson told reporters last week that the government was considering the idea.
Longer-term mortgages would protect customers from interest rate fluctuations much better than the relatively short-term fixed mortgages that are prevalent in the UK. Forty percent of which expire in 2022 or 2023.
The BoE report also notes that while the extreme volatility of cryptocurrencies does not yet pose a risk to overall financial stability, systemic risks would arise if regulation is not put in place.
The market capitalization of the digital asset collapsed from a peak of $3 trillion in November to less than $1 trillion as the failures of the interconnected cryptocurrencies Terra and Luna sent ripples through the broader sector.
“I’m thinking about me [the collapse] underlines the fact that we now need to put in place a regulatory system that manages the risks in the crypto world,” said Sir John Cunliffe, the BoE’s deputy governor for financial stability. “I wouldn’t take the lesson that we shouldn’t do anything because [the problem] gone.”
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