Friday, June 24, 2011
The Bank of England's financial stability report
Posted by David Smith at 02:00 PM
Category: Thoughts and responses

The Bank's financial stability report has always been a little harder to interpret than its sister publication, the inflation report. This one is slightly sifferent, in that it accompanies the recommendations of the interim financial policy committee (in the form of a series of detailed recommendations to the Financial Services Authority).

In time, when supervision has been fully transferred to the Bank, the financial stability report will be a summary/justification of the financial policy committee's own actions.

In the meantime, there's plenty in the report, with the main risk probably best summed up in Sir Mervyn King's opening statement: "The most serious and immediate risk to the UK financial system stems from the worsening sovereign debt crisis in several euro-area countries.

"As the Report makes clear, direct UK bank exposures to those economies are limited. But experience has shown that contagion can spread through financial markets especially when there is uncertainty about the precise location of exposures. A UK bank could have lent to a bank that itself had lent to a bank that in turn was exposed to sovereign risk.

"The Committee therefore judged that greater clarity about the extent of these exposures would help to limit the transmission of problems to UK banks, and that this extra transparency should be a permanent part of major banks’ reporting."

The Bank's systemic risk survey, conducted for the report, finds that the biggest risk to the UK financial system is an economic downturn, cited by 69% of respondents, followed by sovereign debt risks, 65%. However, the downturn factor is down from 83% in October, while the number citing sovereign debt fears is up from 39%. More here.