Bank of England predicts long haul for economy

The Bank of England plans to raise minimum capital levels and impose tight limits on bank leverage, as part of a push to prevent another credit crisis.

In its latest Financial Stability Report, published today, the Bank called for tougher safeguards against systemic risk, and new regulations to ensure banks are in a stronger position ahead of the next downturn.

“We need a fundamental re-think of how to manage systemic risk internationally. We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy”, said John Gieve, chair of the bank’s financial stability board. “Counter-cyclical policy of that sort should complement regulation of companies and broader macroeconomic policy”.

The Bank said it would enforce higher capital levels during times of growth in order to mitigate the effect of the credit cycle. It warned that in benign times many banks did not build up sufficient capital buffers to provide an adequate buffer against market volatility.

To restore capital levels the Bank proposed a leverage ratio - a minimum ratio of capital to total assets - to impose a constraint on the growth of banks’ balance sheets relative to their stock of capital. It also called for for a system of dynamic provisioning to force banks to build up reserves against future losses in good times, and time-varying capital requirements, which link banks’ capital requirements to lending growth, thereby containing asset growth.

The Bank also suggested more restrictive standards on which asset classes can be included in liquidity calculations. “Tougher liquidity standards should also reduce the financial system’s procyclical tendencies — for example, by restricting banks’ ability to expand their lending rapidly using potentially volatile sources of funding, such as some types of wholesale funding”, the report noted.

The report also called for better post-trade processing of over-the-counter derivative trades and improved reporting and transparency standards on bank exposures.

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