At its meeting on 18 September 2013, the Bank of England’s Financial Policy Committee (FPC) reviewed its assessment of the risks to financial stability and, in the light of that assessment, progress against the existing set of recommendations. The Committee did not make any new recommendations.
In the light of the Chancellor’s request, in his remit and recommendations letter to the FPC, that the FPC agree its priorities for future work, the Committee had an initial discussion of its future work programme. That programme will be set out in the November Financial Stability Report.
Since its June meeting, economic prospects for the major advanced economies had improved somewhat, which had supported continued gradual repair of bank balance sheets. But underlying vulnerabilities in the euro area remained and there had been market pressure on some emerging market economies with external vulnerabilities. The broadly positive macroeconomic backdrop and prospect of tapering of asset purchases by the Federal Reserve had been key drivers behind market developments; there had been a significant rise in interest rates along the yield curve. That had underlined the importance, highlighted at the Committee's previous meeting, of financial institutions, and their regulators, ensuring that they were not overly exposed to a sharp correction in market interest rates or credit spreads. But so far the rise in interest rates had not led to dislocations in market functioning or significant impact on financial institutions.
In June, the Committee had recommended that the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA), with other Bank staff, assess the vulnerability of borrowers and financial institutions to sharp upward movements in long-term interest rates and credit spreads. That preliminary work had suggested that a moderate rise in long-term interest rates did not pose an immediate threat to major banks and insurance companies. But responses from firms took account of neither more significant stresses nor potential amplification channels through the financial system. And borrowers would become more exposed to an increase in interest rates were debt levels to rise and some intermediaries were more affected by a shift in credit spreads. The PRA, with other Bank staff, would engage with firms on potential amplification channels that had not been sufficiently covered in firms' risk management exercises. The levels of leverage within, and therefore the vulnerability of, hedge funds needed to be looked at more closely. The FCA, together with staff across the Bank, will undertake further work to enrich the information available to the authorities on hedge funds in order that a more complete assessment of risks to financial stability can be made.
In the United Kingdom, the continued recovery of the banking sector had been associated with a further easing in credit conditions. Against that backdrop, the recovery in the housing market appeared to have gained momentum and to be broadening. Mortgage approvals in July were 30% higher than a year earlier and average house prices in August were 5% higher than a year earlier and had risen more in some parts of the country, particularly London. Nevertheless, activity in the housing market and loan-to-value ratios on new mortgage lending remained below their historic averages. Households’ debt servicing costs were low and the ratio of house prices to earnings was at its level of a decade ago. In view of that, the Committee judged that it should closely monitor developments in the housing market and banks' underwriting standards. The Committee would be vigilant to potential emerging vulnerabilities. The Committee noted that if risks to the stability of the financial system were to emerge from the housing market, both it and the microprudential regulators had a range of tools available to address those risks. These included, amongst others, supervisory guidance on underwriting standards, sectoral capital requirements and recommendations to the regulators on tightening of affordability tests. The Committee agreed that, if it became necessary to deploy its tools, they would be used in a way that was proportionate to the risks and consistent with a graduated response.
In the context of the Monetary Policy Committee’s (MPC) Forward Guidance framework, the FPC also discussed whether the stance of UK monetary policy posed a significant threat to financial stability which could not be addressed by prudential or other regulatory tools. In line with the process set out in the MPC’s Forward Guidance document, the FPC’s position on the financial stability 'knockout', together with the MPC’s response to it, will henceforth be published no later than the minutes of the following MPC meeting.
The Committee reviewed progress on its other recommendations in the light of prevailing risks to financial stability.
The Committee reviewed progress by Her Majesty’s Treasury and the regulators towards a programme of work to test and improve the financial system’s resilience to cyber attacks. It encouraged Her Majesty’s Treasury and the regulators to ensure that the various institutions at the core of the financial system, including banks and infrastructure providers, had a high level of protection against cyber attacks to ensure such attacks do not undermine the system. The Committee agreed to review progress at its subsequent meetings.
It noted the progress towards issuing a Bank discussion paper on the design of a stress testing framework to assess the capital adequacy of the UK banking system. The Committee had discussed a draft with the PRA Board. The discussion paper will be published, alongside the Record of the Committee’s meeting, on 1 October.
The Committee concluded that the PRA had implemented its June 2013 recommendation on reducing the application of the Liquidity Coverage Ratio, and also its March recommendation that the PRA consider the case for higher required capital ratios for firms with idiosyncratic vulnerabilities, such as a high degree of leverage relating to trading activities. The Committee will continue to review progress on both of these issues and against its other recommendations.
The Record of the Committee's meeting will be published on 1 October.