By Central Bank News
UK banks should continue to limit dividends and executive compensation and instead use the funds to boost their capital cushion to absorb any possible losses during the current risk to financial stability from the crises in the euro area, the governor of the Bank of England said.
In his prepared remarks for a press conference, Mervyn King said the cushion that banks should build up may even be larger than the current planned increase toward meeting the tougher Basel III capital requirements.
“The Committee continues to believe that there is a need for banks temporarily to raise their levels of capital, in view of the exceptional threats they currently face,” King said presenting the bank’s Financial Stability Report.
That additional capital cushion should be used in the event that losses actually occur so banks don’t end up cutting back lending to consumers and businesses to cover the losses.
“At that point, or if the current risks recede, banks’ capital ratios could then fall back to the official transition path to the Basel III standards,” King said, rejecting arguments that increasing the capital cushion would limit banks’ capacity to lend.
“More capital and more lending go together,” King said. “Moreover, in the event that large losses are realised as a result of the euro-area crisis, it is vital that our banks are sufficiently well capitalised to be able to continue to provide the services on which we all rely.”
UK banks have been building up their liquidity buffers in recent years and they are now above official guidance levels. In addition, the banks can access liquid funds through the bank, specifically through the BOE’s recently-extended extended repo facility and its discount window, King said.
“That has put banks in a strong position to withstand a period of market stress. But it is important that banks are willing to make use of their liquid asset buffers in times of stress, in order to support lending to the real economy,” King said
The Financial Stability Report was prepared by the BOE’s Financial Policy Committee (FPC), set up last year to reduce systemic risks to the UK financial system. The creation of the FPC was part of the UK’s wholesale reform of financial regulation, which gave power to the bank’s FPC to address overall financial stability. It also set up a new Prudential Regulatory Authority at the BOE that would focus on systemically-important financial institutions.
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