Despite the economic crisis resulting from the Covid-19 pandemic, banks in the UK remain in good shape to weather future challenges.
That’s the conclusion of the Bank of England in its latest bi-annual Financial Stability Report, which looks at risks to the financial sector and seeks to understand how financial institutions can deal with challenges.
In the report, the Bank concludes that banks remain in good shape, despite taking more risks in global markets and factors including soaring house prices and higher corporate debt levels.
The report says, “The FPC continues to judge that the banking sector remains resilient to outcomes for the economy that are much more severe than the Monetary Policy Committee’s central forecast.”
Despite significant risks in the financial sector, the Bank’s Financial Policy Committee (FPC) believes investors are taking even riskier positions in global markets.
They assessed that investment fund managers are taking on more risk, and their underwriting standards in some sectors were becoming more relaxed.
This approach to risk could lead to investors suffering some significant losses during a future market correction.
The report continued, “Risky asset prices have continued to increase, and in some markets asset valuations appear elevated relative to historical norms. This partly reflects the improved economic outlook, but may also reflect a ‘search for yield’ in a low interest rate environment, and higher risk-taking.”
Also within the report, the Bank looks at rising cryptocurrency prices and the rising popularity of Special Acquisitions Companies (SPACs), both indicators of increased risk-taking in financial markets. The report authors wrote:
“Rapid appreciation of cryptoasset valuations and recent high levels of price volatility in these instruments could highlight potential pockets of exuberance.”
While the Bank does not think cryptocurrencies are likely to present a risk to financial stability, as retail investors mostly own them, increased interest from institutional investors could change this risk outlook.
Turning to house prices, the report notes that market valuations and activity are at their highest level in a decade, despite the impact of the pandemic, and this could be another sign of market exuberance.
However, despite the property market boom, the committee does not believe that households have taken on unsustainable levels of mortgage debt. They said that the measures already in place to limit any rapid build-up of indebtedness seem to be working.
The Bank reached a similar conclusion on corporate debt levels, despite businesses borrowing £80 billion to date via government-backed Covid loans.
But businesses in the UK have not increased their corporate debt levels markedly, and their repayments remain affordable. The report said, “The FPC judges that UK corporate debt vulnerabilities have increased modestly.”
As the UK economy continues to recover from the impact of the pandemic, the Bank believes that individuals and businesses will continue to need financial support from banks.
The report said, “Households and businesses are likely to need continuing support from the financial system as the economy recovers and the Government’s support measures unwind over the coming months.”
“The FPC expects banks to use all elements of their capital buffers as necessary to support the economy through the recovery. It is in banks’ collective interest to continue to support viable, productive businesses, rather than seek to defend capital ratios by cutting lending.”
In light of the report, the Bank of England has scrapped the remaining restrictions on bank dividend payouts.
With bank balance sheets in good shape, the Bank confirmed that they could remove the so-called ‘guardrail’ limits on dividend payments to investors.