Financial Policy Summary and Record - March 2019

• Extensive legislative and other preparations have been made by UK authorities to ensure UK households and businesses can use existing and new services from EU financial institutions.  EU authorities have mitigated risks of material disruption to cleared derivatives markets.
• However, some disruption to cross-border services is possible and, in the absence of other actions by EU authorities, some potential risks to financial stability remain.  Although these would primarily affect EU households and businesses, they could also be expected to spill back to the UK in ways that cannot be fully anticipated or mitigated.
  • UK and global banks are transferring activities to EU-incorporated entities, but are not yet in positions to provide the full range of wholesale banking services to EU clients.
  • The process of migrating businesses, assets and contracts in a short period also poses operational risks, which could disrupt services in the EU.  
  • Banks in EU countries, which have not passed relevant legislation, and their UK counterparty banks will also be less able to manage the risk arising from their uncleared derivative positions.

Banks are much stronger than before the financial crisis

• Major UK banks’ capital ratios are more than three times higher than before the global financial crisis.  These banks have large buffers of capital that can be used to absorb losses while continuing to lend to households and businesses.
• As a result, they would be resilient to a worst case disorderly Brexit scenario in which there is: a sudden imposition of trade barriers with the EU; loss of existing trade agreements with other countries; severe customs disruption; a sharp increase in the risk premium on UK assets; and negative spillovers to wider UK financial markets.  
• In the event that severe global stresses were to emerge at the same time as a worst case disorderly Brexit, generating an even deeper downturn in the UK economy, the banking system would have sufficient capital to withstand the resulting losses on its UK and international exposures. 

• In a disorderly Brexit, a range of UK asset prices – including the sterling exchange rate, equities, corporate and government debt and bank funding costs – would be expected to adjust sharply, tightening financial conditions for UK households and businesses.
• EU banks and insurance companies could immediately face tougher prudential requirements on their holdings of UK sovereign and bank debt when the UK leaves the EU, reducing demand for UK assets.
• More generally, the UK faces risks from a reduction in foreign investor appetite for UK assets, which could amplify any market volatility and repricing of assets in a disorderly Brexit.  Commercial Real Estate (CRE) and leveraged lending markets in particular are dependent on foreign capital.  
• As demonstrated after the referendum in 2016, sterling markets are able to function effectively through markedly volatile periods.  The strength of the core financial system, including banks, dealers and insurance companies, supports the markets on which the economy relies.

• With over £1 trillion of liquid assets, major UK banks are able to meet their maturing obligations for many months without any need to access wholesale funding or foreign exchange markets.
• The Bank is able to lend in all major currencies. The FPC welcomes the recent Bank decision to increase the frequency of the Bank’s sterling liquidity operations and to initiate a new weekly Liquidity Facility in Euros (LiFE), alongside the existing weekly dollar lending facility.

• The tightening of financial conditions and the slowing in domestic and global growth in late 2018 represent the partial realisation of some risks that had been previously identified by the FPC, rather than an increase in underlying vulnerabilities.
• In the global economy, debt vulnerabilities remain material in China and some emerging markets, the US corporate sector and Italy.
• In the UK, credit growth has slowed but is in line with income growth and debt servicing burdens remain low, consistent with a standard level of underlying vulnerability.
• Measures of implied volatility and the valuation of some assets factor in a relatively benign outlook for inflation, and appear inconsistent with the degree of uncertainty about a range of economic policies in the global economy.

Global debt vulnerabilities remain material

Countercyclical capital buffer rates

The countercyclical capital buffer (CCyB) is a tool that enables the FPC to adjust the resilience of the banking system. The FPC increases the CCyB when it judges that risks are building up. This means that banks are required to have an additional cushion of capital with which to absorb potential losses, enhancing their resilience and contributing to a stable financial system.

Our stress test is more severe than the shocks experienced during the financial crisis

• Reflecting the FPC’s assessment that the underlying vulnerabilities are broadly unchanged on the year, the stress test scenario is very close to that in the 2018 ACS.  As such, it remains tougher than the financial crisis. The FPC and Prudential Regulation Committee (PRC) will use the test to assess bank balance sheets and the resilience of the financial system.
• The FPC agreed that from 2020, the ACS will assess the ring-fenced subgroups of existing ACS participant banks on a stand-alone basis.