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The Bank of England has announced plans to ease a key capital requirement for UK banks despite concerns among some officials that it will add to risks in the financial system.
The BoE’s Financial Policy Committee, which oversees stability of the financial system, said on Tuesday it would lower the leverage ratio, which caps banks’ borrowing by setting a minimum level of capital they must maintain against their total assets.
The move, which is intended to boost lending and support the functioning of financial markets during a crisis, marks the latest step by regulators to ease the restrictions imposed on the banking system after the 2008 financial crisis.
The FPC said the change would cut the overall leverage ratio by about 0.2 percentage points of UK banks’ assets. Andrew Bailey, BoE governor, said the “targeted” changes were designed to address “the anomaly” of UK domestic-focused banks having higher leverage ratio requirements than many foreign rivals, as well as their more globally focused UK peers. “Making changes to our capital framework is a finely balanced judgment,” he added.
The central bank added that, combined with plans to ease other bank capital rules in a crisis, it would “make it easier for banks to use capital to support lending and the functioning of core markets in stress, while maintaining overall consistency with international standards”.
Morgan Stanley bank analysts have forecast the BoE’s planned reforms will give the main UK lenders £270bn of additional balance sheet capacity, predicting as much as half could be used to buy gilts.
The BoE said that “some FPC members were concerned that the proposal might lead to an unwanted increase in market-based leverage, with implications for the resilience of core UK markets” and it planned to examine “potential mitigations”.
Bailey said that “we have got some more work to do” to decide how to address its concerns about high leverage in debt and equity markets. The FT recently reported that the BoE plans to push ahead with measures to limit how much debt hedge funds can use to bet on UK government bonds.
The moves came as the central bank said vulnerabilities in the financial system “have become more pronounced” in recent months, including “the increased use of leverage in equity markets” that has contributed to a surge in stock market prices.
“Despite the challenging global risk environment, by some metrics equity valuations continue to be stretched relative to earnings,” the BoE said in its twice-yearly financial stability report.
The rapid rise in share prices of companies linked to artificial intelligence has pushed valuations in the S&P 500 index of leading US-listed companies measured in relation to their earnings to “levels not seen since the dotcom bubble” in 2000, it said.
“The risk of a sharp correction in equity markets remains high,” the BoE said. The amount of debt provided by investment banks to hedge funds to make leveraged bets on equity markets has risen 40 per cent in the past year to record levels, it added.
The BoE also warned that rapid advances in frontier AI capabilities had “increased financial stability risks related to cyber and operational resilience”.
The central bank said it was also troubled by historically high levels of government debt issuance, hedge funds’ heavy use of debt for betting on gilt markets, and growing risks in private credit markets, adding it was “particularly concerned that a number of these vulnerabilities could crystallise simultaneously”.
In an update on its debut stress test of private credit markets, the BoE said it had collected information on private equity and private credit investments in 520 UK companies, which on average had debts of about six times their earnings.
Outlining plans to reform bank capital requirements, the BoE said an extra capital buffer for larger domestic-focused lenders — Lloyds Banking Group, NatWest, Nationwide and Santander UK — would be cut to zero in a crisis to help them maintain lending. A consultation on this change will happen later this year.
It also set out plans to ease the leverage ratio. Part of the leverage ratio will become “releasable” in a crisis to help banks maintain lending levels during financial stress. It will also scrap an extra buffer added to the leverage ratio, while increasing another applying only to the most global lenders — those with bigger investment banking operations, such as HSBC, Barclays and Standard Chartered.
Banking trade body UK Finance said the changes were “important initial steps” but called for further reductions in capital requirements to “support more lending”.
The move comes after US regulators eased their leverage ratio rules earlier this year, prompting the biggest Wall Street banks to report a drop in their capital levels in proportion to overall assets in the first quarter.
