UK banks face growing risk from Eurozone crisis

London: Britain's banks face growing risks from the Eurozone debt crisis, but may need to run down capital levels to keep credit flowing rather than building up additional buffers to deal with losses, the Bank of England (BoE) said yesterday.

The Financial Policy Committee's (FPC) line runs counter to a debate in Europe, which is focused rather on how much extra capital would be needed to help banks ride out the impact of Greece and potentially other Eurozone members defaulting.

Britain's banks already have among the highest levels of core capital in the world at well over 10 per cent.

The FPC — set up on an interim basis pending approval of a draft law — also called for powers to intervene over bank balance sheets, the terms of market transactions, and trading systems, to help identify and tackle potential financial crises.

Strains

The committee said that since its last meeting in June, there had been severe strains due to the Eurozone debt crisis.

"Anxiety about the consequences of these issues for banks had increased materially and, in turn, the perceived vulnerabilities of banks were adding to strains in financial markets," it said. In recent weeks markets have become more convinced that Greece will default on its debt, triggering big sell-offs of shares in European banks which hold the country's sovereign bonds.

The statement echoed similar concerns last week from the EU's European Systemic Risk Board, whose vice-chairman is BoE Governor and FPC chairman Mervyn King.

Unsustainable debt positions of euro area countries would need long-term reforms, but "given the scale of the current risks" short-term action was needed to keep credit flowing from banks to the economy, the FPC said.

In June the FPC recommended that banks beef up capital levels, but in yesterday's statement it said that some actions to raise capital or liquidity "could potentially worsen the feedback loop between the financial sector and the wider economy and so should be avoided".

Britain's financial services regulator has so far been among the toughest in forcing banks to run high capital buffers, and the FPC's statement points to concern that may have a negative impact on growth.

The FPC also said that "in the event that severe risks crystallised, it would be natural for banks' capital and liquidity ratio to be run down to ensure that lending to the non-financial economy was not impaired".

Nomura bank said the FPC now sounded "much more accommodative" as the committee noted progress made so far in building up capital and liquidity buffers.