BoE Report Examines Stability of Financial System in UK

The financial stability report highlights that the FPC judges that the UK banking system remains resilient to a wide range of possible economic outcomes. The financial system has the capacity to continue to support households and businesses, even if economic outcomes are considerably worse than expected. During 2020, the aggregate common equity tier 1 capital ratio of the major UK banks and building societies (banks) increased to 15.8%. However, headwinds to bank capital ratios are anticipated during 2021. Nevertheless, banks remain well-capitalized and able to support the economy. FPC expects banks to use all elements of capital buffers, as necessary, to continue to support the economy. Looking ahead, a number of factors are likely to weigh on the capital positions of banks. For example, the credit losses banks have taken so far will be followed over time by an increase in risk-weighted assets, as the underlying deterioration in credit quality begins to be reflected in risk-weights. Furthermore, as insolvencies rise and more impaired loans default, the benefit banks get from the IFRS 9 transitional relief will fall away. Analysts expect banks to incur further impairments during 2021.

The report notes that the mortgage credit conditions remain tighter than at the start of the year, particularly for high loan-to-value (LTV) mortgages. FPC is reviewing its mortgage market measures, including their calibration, and plans to report its conclusions in 2021. In addition, the report highlights that FPC and PRC will conduct a stress test of the major UK banks and building societies in 2021. This stress test will be a cross-check on the judgment of FPC on bank resilience to a reasonable worst-case stress in the current environment. The results will be used as an input into the transition of PRA back to its standard approach to capital-setting and shareholder distributions through 2021. The report also states that FPC and PRA would resume the launch of the biennial exploratory scenario on climate change risk, with a launch date of June 2021, as announced in November 2020. The exercise will explore resilience of the largest UK banks and insurers to three climate scenarios, testing different combinations of physical and transition risks over a 30-year period. 

The report presents a response from FPC to the recommendation of HM Treasury on the publication of an assessment of the oversight and mitigation of systemic risks from the non-bank financial sector by the end of 2020. The response sets out the reasons why FPC intends to publish this assessment in the first half of 2021. FPC is also taking forward its consideration of risks from payment systems that could attain systemic importance in UK, including new forms of payments involving stablecoins. The report notes that stablecoins could provide benefits to users, but they can be adopted widely and become successful as a safe and trusted means of payment only if they meet appropriate standards. FPC is considering the potential effects on financial stability more broadly if stablecoins were to be adopted widely. A discussion paper on these issues will be published in due course by BoE. The paper will also address issues that may arise in connection to the introduction of a Central Bank Digital Currency. 

Related Links

• Financial Stability Report
• Record of FPC Meeting
• Response from FPC to HM Treasury

Keywords: Europe, UK, Banking, Insurance, Securities, COVID-19, Financial Stability Report, Stress Testing, Credit Risk, Brexit Transition, Biennial Exploratory Scenario Exercise, Systemic Risk, FPC, Stablecoins, CBDC, BoE