BoE imposes new capital buffers due to 'pocket of consumer credit risk'
The Bank of England will call for banks to increase the amount of capital buffers they hold by £10bn as it warned that risks from rising debt are building in the UK and overseas based on overconfidence that recent benign conditions will continue.
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While the central bank Financial Policy Committee was relatively relaxed about the levels of current domestics risk for the overall economy, it calculated that another financial downturn could see around one in five consumer credit loans being written off.
High street banks have been told by the FPC that the UK countercyclical capital buffer rate will be maintained at 0.5% but is likely to be increased to 1% in November as there is felt to be a low level of domestic risk, with only 1% of households facing potential mortgage repayment difficulties.
In its report on Monday the FPC warned that there was a "pocket of risk" in consumer credit, which while not a material risk to overall UK economic growth, is a risk to banks’ ability to withstand severe economic downturns as the asset class is disproportionately more likely to default.
"Although the overall credit quality of consumer credit has improved significantly since the financial crisis, the FPC judges that lenders overall are placing too much weight on the recent performance of consumer lending in benign conditions as an indicator of underlying credit quality. As a result, they have been underestimating the losses they could incur in a downturn," the committee said in a report on Monday.
In the event of a downturn, UK banks would incur UK consumer credit losses of around £30bn, or 20% of UK consumer credit loans, the FPC and Prudential Regulation Committee calculated.
Detailed results of this stress test scenario and the individual buffer amounts will be published for each bank on 28 November, with banking analysts highlighting Barclays and Lloyds as having the largest exposure to consumer credit compared to the other five banks being tested HSBC, RBS, Nationwide, Santander UK and Standard Chartered.
"Regulatory capital buffers for individual firms will be set following the full stress test results so that each bank can absorb its losses on consumer lending, alongside all the other effects of the stress scenario on its balance sheet," the FPC said, adding that it also expects banks "will begin to factor these market-wide levels of stressed losses on consumer credit into their overall lending and capital plans".
The BoE also highlighted other global risks, including that financial vulnerabilities in China are "pronounced"; that US corporate leverage has risen to new highs; that global corporate bond spreads have narrowed to "unusually low levels"; and that some asset prices "appear vulnerable to a repricing" through increases in long-term interest rates and/or adjustment of growth expectations.
Economist Paul Hollingsworth of Capital Economics said the BoE had fired a warning shot to UK banks over consumer credit.
"It should be noted that the FPC does not think that the recent rapid growth in consumer credit poses a risk to economic growth, through a sharp pull-back in consumer spending. Instead, it thought that banks have been placing too much weight on the recent low level of losses on consumer credit as an indication of an improvement in the underlying quality of loans, rather than a reflection of the supportive macroeconomic environment."
Hollingsworth this extra capital requirement was "not especially large, compared to the £280bn of core capital held by banks, and so is unlikely to have too significant an impact on consumer credit", though some banks will be hit harder than others.
Noting that that credit growth had already started to come off the boil in recent months, he added: "In any case, with inflation likely to fall back after peaking around October, and some acceleration in wage growth in prospect, the foundations for spending growth next year should be stronger, so concerns about consumer credit are likely to diminish, rather than build further."