In the Financial Policy Committee’s (FPC’s) financial policy and summary record for October, it said it continued to judge that major UK banks have “considerable capacity” to support lending “even with the further deterioration in the economic outlook”.
It said banks’ capital and liquidity positions were still strong and on the whole, profitability had strengthened. Capital ratios, the amount of capital banks hold in relation to risk, had fallen in Q2, but the FPC said they maintained headroom above what was required by regulation.
Asset quality is expected to worsen, which will lead to a rise in impairments and risk-weighted assets, but banks’ profits will benefit from the high interest rate environment.
Pulling back on lending more harm than good
The FPC said banks would also be able to withstand severe economic outcomes but would likely “prudently” manage lending activity to align with any changes to credit quality in the real economy.
It said adjusting lending terms to reflect any new risk was appropriate but restricting lending just to defend capital ratios or buffers “would be counterproductive”. It would also “prevent creditworthy businesses and households from accessing funding”.
It said excessive tightening of lending would “harm the broader economy and ultimately the banks themselves”.
The FCA said it would continue to monitor the bank sector’s resilience in the stress test and their risk appetite for lending.
A resilient market
The UK banking sector is “substantially more resilient” than it was before the global financial crisis, due to higher levels of capital and liquidity, the FPC suggested.
In September, the FPC started its latest annual cyclical scenario (ACS) stress test which gauges the risks to the banking system during a financial cycle.
It will also maintain the countercyclical capital buffer (CCyB) rate at two per cent. This will come in from July 2023 and ensure banks have the resilience to lend in stress. This rate is set each quarter and is a tool for banks to build capital in periods of growth, so this can be used to absorb losses and retain lending in a downturn.
“We stand ready to vary this rate in either direction in future, depending on how risks develop,” the FPC said.
Household impact
The FPC said households were in stronger financial positions than they were during the lead up to the global financial crisis, meaning UK banks were less exposed to vulnerabilities.
The Energy Price Guarantee is expected to lessen a near-term peak in CPI inflation alongside other government support. Conversely, other factors increasing costs include mortgage payments and other borrowing, which is expected to put pressure on the finances of households and businesses in coming months.
The FPC’s report noted that overnight swap rates, which determine mortgage pricing, had peaked to six per cent at the time of its policy meeting on 30 September. It said if mortgage rates followed this trend, the share of households using a high portion of their income to service their mortgage debt would rise by the end of 2023 and peak to levels seen before the global financial crisis.
However, excluding student loans, the FPC said the ratio of household debt to income and the share of outstanding mortgage debt at high loan to value ratios were lower.
It also said lenders were now required to use flexible approaches to repayments and only use repossessions as a last resort.
The FPC added: “Nevertheless, it will be challenging for some households to manage the projected rises in the cost of essentials alongside higher interest rates.”
