Friday, June 25, 2010
The Bank of England's Financial Stability Report - still a long way to go
Posted by David Smith at 09:00 AM
Category: Thoughts and responses

The Bank of England's Financial Stability Report, published twice-yearly, will take on a greater importance in the new era, as it should have done in the old. The highlights of the latest are that there has been a huge balance sheet adjustment - UK households saved more than they borrowed last year for the first time on record - but that this is no time for complacency, either in the banking system or elsewhere.

There are strains arising from eurozone sovereign debt worries, from the banks' own refinancing needs and from other factors, raising doubts about whether lending will be strong enough to support the recovery. This is its summary:

"The financial system has been significantly more stable over the past six months, underpinned by the authorities’ sustained support for the banking system and monetary policy measures. Low risk-free interest rates and reduced uncertainty among investors have led to a rebound in a range of asset prices. Activity in many capital markets has resumed, reducing financing risks for some
borrowers. The market rally has boosted bank profits and lowered concerns about potential future losses, and banks have raised further external capital. As solvency concerns have eased, banks have been able to issue unguaranteed term debt, helping them to reduce their reliance on short-term funding.

"But overstretched balance sheets will take time to adjust fully. Around the world, a number of borrowers, including in the commercial property sector, have large refinancing needs in the coming years. And while funding costs remain low, there is a risk of market participants building excessively risky positions, which could unwind abruptly when yield curves eventually rise. Banks need to reduce leverage further, extend the maturity of their funding and refinance substantial sums as official sector support is withdrawn. While their profitability is relatively buoyant and market conditions are broadly favourable, banks should take the opportunity to do so. That will reduce the risk of disruption to the flow of credit in the future." The report is here.