The statement from the FPC’s 12 March meeting noted that UK companies issued more leveraged loans and high-yield bonds in 2017, while valuations in commercial real estate appear “stretched”.
More so, the proportion of new owner-occupier mortgages with high loan-to-income ratios – including just below 4.5 – have increased, and spreads between mortgage rates and risk-free rates have tightened.
The FPC also judged that apart from Brexit, domestic risks remain standard, and the main risks come from global financial vulnerabilities such as high corporate debt in the United States and elevated risks in the Chinese markets.
The committee acknowledged that the UK has a large deficit by international standards and the capital inflow funding for the deficit is raising the UK’s reliance on the confidence of foreign investors
The FPC said that the UK banking system was well capitalised and could continue to support the real economy through a disorderly Brexit, so that Brexit risks did not warrant additional capital buffers and kept the counter-cyclical capital buffer rate at 1%.
The committee added that it will revisit the rate at the next meeting in June.
However, the FPC also acknowledged that “material risks remain, particularly in areas where actions would be needed by both the UK and EU authorities,” such was the potential for a disorderly Brexit to affect cross-border financial contracts and insurance markets.
The Bank of England identified £26trn of uncleared contracts, £70trn of cleared contracts, and approximately £83bn of insurance liabilities covering around 50 million people which could be affected by Brexit
Cleared contracts are those which take place on an exchange, while uncleared trades are those that take place between parties directly.
Meanwhile, the Office for Budget Responsibility recently estimated Brexit to cost public finances a minimum £37.1bn.
The FPC’s assessment on financial stability also touched on cryptocurrencies.
The committee judged that existing crypto-assets do not pose a risk, and in fact mentioned the potential benefits of the technologies underlying crypto-assets in creating “a more distributed and diverse payments system”.
However, if crypto-assets became more widely used for payments or as a value storing asset, the FPC said it would apply current financial stability standards on the relevant payments and exchanges.
The 2018 round of stress tests will see banks play out the same scenario as in 2017, with interest rates at 4%, a -4.7% GDP contraction amid a global recession, and a -33% fall in house prices – a simulation worse than the financial crisis.
Banks will also need to pass more stringent capital hurdles, due to new accounting rules that require banks to register losses from loans faster. The BoE also added that banks of greater systemic important will be stressed to higher standards.