February 14, 2018

IMF issued staff report and selected issues report in the context of the 2017 Article IV consultation with the United Kingdom (UK). Directors welcomed the recent progress in negotiating the departure of the UK from EU, which allowed discussion to move to issues related to a transition period and the framework for the future relationship. Directors commended the authorities for proactively helping financial institutions to prepare for the exit, given the uncertainties about the future of financial service arrangements with the EU. They called on all involved parties to work together to mitigate transition risks related to changes in regulatory regimes and responsibilities.

The staff report highlights that the major UK banks are well-capitalized and satisfy the Basel III liquidity coverage ratio and net stable funding ratio requirements. However, strong regulatory capital ratios benefited from declining risk-weights on mortgages and consumer loans, partly reflecting benign cyclical conditions and declining nonperforming loans. The 2017 annual stress test of BoE suggests that the UK banking system is resilient to deep simultaneous recessions in the UK and global economies, large falls in asset prices, and a separate stress of misconduct costs. Moreover, strengthening of the bank resolution framework is on track: large core retail banking operations will be ring fenced by 2019 while banks are raising their total loss-absorbing capacity and satisfying resolution planning requirements. Adopting the Basel III final agreement in due time would help reduce excess variability in risk-weights across banks using internal models.

The staff report notes that the Executive Directors encouraged the authorities to maintain robust prudential and supervisory standards and to continue monitoring consumer credit and bank risk-weights. The countercyclical capital buffer (CCyB) was lowered to prevent a tightening of credit conditions. BoE increased the CCyB to 1% in November 2017, reflecting its assessment that—excluding the impact of Brexit—the risk environment is close to a standard level. Any relaxation of the CCyB would need to maintain confidence in the financial system and ensure an appropriate degree of resilience against future shocks.CCyB rate should be kept under review to ensure it continues to evolve in line with the overall risk level. The authorities should consider conducting a system-wide liquidity stress test of the major UK banks in a future biennial exploratory scenario. Stable liquidity conditions are important for the smooth functioning of capital markets. Following the recommendations of the 2016 FSAP, BoE is developing a financial-system-wide simulation to model the dynamic interaction of insurers, funds, and dealers under stress. 

The staff report also emphasizes the major Brexit-related challenges to the UK financial sector. The 2017 annual cyclical stress test of BoE suggests that the major UK banks are sufficiently well-capitalized to withstand a disorderly Brexit. However, even an orderly Brexit could pose significant business continuity challenges. Financial institutions have been asked to develop comprehensive contingency plans in consultation with BoE. Based on a review of these plans, the authorities have identified two key issues that would be difficult for financial firms to address unilaterally and could best be handled through bilateral agreements between the UK and EU. These include the continuity of outstanding cross-border over-the-counter derivative and insurance contracts and the continued cross-border sharing of personal data within institutions. Regulation and oversight arrangements for euro denominated derivatives clearing on UK-based central counterparties will require careful design. The report states that a broad agreement on the new economic relationship with the EU must be achieved by March 2019. The selected issues report examines the key factors behind the slowdown of the wage growth and the regional disparities in labor productivity in the United Kingdom.

 

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Keywords: Europe, UK, Banking, Insurance, Securities, Basel III, CCyB, CCP, FSAP, Article IV, IMF

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