01 December 2011

BoE: Financial Stability Report December 2011

The symptoms of the crisis have been widely reported. Many European governments are seeing the price of their bonds fall, undermining banks’ balance sheets. In response, banks, especially in the euro area, are selling assets and deleveraging. An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts. That, in turn, will weaken banks’ balance sheets further. This spiral is characteristic of a systemic crisis.

Tackling the symptoms of the crisis without resolving the underlying causes, by measures such as providing liquidity to banks or sovereigns, offers only short-term relief. Ultimately, governments will have to confront the underlying causes. A loss of external competitiveness in some euro area countries has led to current account imbalances and large build-ups of private and public debt, much of it external. The problems in the euro area are part of the wider imbalances in the world economy. The end result of such imbalances is a refusal by the private sector to continue financing deficits, as the ability of borrowers to repay is called into question.

Resolving these wider problems is beyond the control of any UK authority. The responsibility of the Financial Policy Committee is to focus on measures that can protect and enhance the resilience of the UK financial system in this threatening environment, and ensure it is better equipped to counter even more serious potential problems further down the road.

The interim Financial Policy Committee (FPC) agreed the following policy recommendations:

• Following its recommendation from September, and given the current exceptionally threatening environment, the Committee recommends that, if earnings are insufficient to build capital levels further, banks should limit distributions and give serious consideration to raising external capital in the coming months.
• The Committee reiterates its advice to the FSA to encourage banks to improve the resilience of their balance sheets without exacerbating market fragility or reducing lending to the real economy.
• The Committee recommends that the FSA encourages banks to disclose their leverage ratios, as defined in the Basel III agreement, as part of their regular reporting not later than the beginning of 2013.

Full report

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