UK banks made it through the initial Brexit turmoil without undue stress on their liquidity or borrowing costs. Now the Bank of England is moving to reassure investors that even a recession, and the potential impact on earnings and asset prices, won’t put them at risk of breaching minimum capital levels.
With the economic outlook darkening after the nation’s decision to leave the European Union, the central bank will announce as soon as next week that lenders won’t be required to set aside extra capital next year under a measure known as the countercyclical capital buffer, people with knowledge of the discussions said. The buffer is designed to guard against the cycle of banks excessively boosting lending in good times, then slashing credit in a downturn.
“It would’ve been inconsistent for the Bank to have gone ahead with this buffer when they expect the economy to grow at a slower pace,” said Laurie Mayers, associate managing director, banking, for Europe, the Middle East and Africa at Moody’s Investors Service. “Banks are feeling pressure on profitability; they were prior to the referendum. This helps by not adding to pressures that would’ve only gotten worse.”
BoE Governor Mark Carney has sought to calm markets rattled by the shock of Brexit and the chaos engulfing Britain’s political classes. In a televised address on Thursday, Carney signaled the central bank could cut interest rates within months and said officials won’t hesitate to act when it comes to safeguarding the economy or the resilience of the financial system. He’s acted after British bank stocks plunged in the week since the June 23 vote, wiping more than $40bn from their value, as fears spread a drawn-out downturn would slash earnings and threaten London’s central role in global finance.
“The Bank of England has got a lot of tools,” Barclays Chief Executive Officer Jes Staley said in a Bloomberg Television interview with Erik Schatzker on Thursday. “They’ve got monetary policy, which can be very accommodating. They’ve got capital regulations with the British banks and Barclays, which allows them to move capital such that we are more available to give credit, the countercyclical buffers. There’s the liquidity support that the governor spoke about.”
The BoE’s Financial Policy Committee, which met this week, will reverse its March increase of the countercyclical capital buffer for UK exposures to 0.5% of risk-weighted assets from zero, according to the people familiar with the decision, who asked not to be identified because the information isn’t public. That increase was to become binding from March 29 next year and was based on rosier economic projections. A Bank of England spokeswoman declined to comment.
Britain’s FTSE 350 Banks Index gained 0.9% at Friday’s close in London. Barclays was up 1%, while Lloyds Banking Group climbed 0.5%. Both have fallen at least 25% in the past week and the industry recorded its biggest two-day decline in seven years in the immediate aftermath of Brexit.
Lenders are likely to face a host of problems including a squeeze in their net interest margins, increased funding costs and a rise in loan defaults amid market volatility and slowing economic activity in the coming years, Antonio Garcia Pascual, an analyst at Barclays, said in a note.
While analysts have questioned lenders’ earnings outlooks – downgrading the ratings of Barclays, Lloyds and Royal Bank of Scotland Group en masse – bank executives have said they haven’t seen stress in funding markets. The London interbank offered rate, a measure of how much it costs banks to borrow from one another, has remained stable.
Finance chiefs on Thursday expressed confidence in the BoE’s response to the shock and the previous measures put in place. HSBC Holdings Chairman Douglas Flint and RBS Chairman Howard Davies both credited stringent capital rules in recent years in helping lenders manage the recent turmoil and not contribute to stress like in previous crises.
Lowering the countercyclical buffer would reduce the risk of a UK bank being forced to stop payment of dividends, bonuses or coupons on additional Tier 1 debt. EU law sets limits on such payments when banks eat into their capital buffers, aiming to help struggling institutions conserve capital to regain a solid footing.
Easing the buffer can also encourage banks to continue lending in a downturn, rather than pulling back in an effort lower both their risk-weighted assets and loan losses and thus boost their capital ratios.
It is “a clear sign that the BoE really does see capital buffers as there to be used, which would be a welcome vote of confidence in the new system,” Philip Rush, an economist at Nomura International Plc, said in an e-mail.
Economists including those at Goldman Sachs Group and Bank of America Merrill Lynch have forecast an economic contraction in the UK. Both said the impact of the vote could subtract about a cumulative 2.5% from GDP. The British government signalled it is no longer seeking to deliver a budget surplus by 2020 as a consequence of the result.
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