Banks must go further to raise external capital reserves, Bank of England warns

At its quarterly meeting, the interim Financial Policy Committee (FPC) said that although banks had made "some progress" towards a similar recommendation issued in November, the overall outlook for global financial stability remained "fragile".

It also set out the initial powers it believes that it needs in order to effectively monitor the country's economic stability when it takes on its regulatory role under the forthcoming Financial Services Bill. However it stopped short of recommending it be allowed to set minimum income or deposit requirements for individual borrowers, stating that these powers would need to be fully debated in order to foster a "high level of public acceptability" before they could be implemented.

The interim FPC was established in 2011 in anticipation of the statutory FPC which will be created by new legislation which will restructure the existing system of financial regulation in the UK. It handles so-called 'macro-prudential' issues that may threaten economic and financial stability.

In a letter to the Treasury (1-page / 328KB PDF) it has requested the ability to order banks to raise or lower their capital buffers, to target specific economic sectors and to limit the amount that banks are able to borrow as a proportion of their assets.

The new Financial Services Bill, which is currently before Parliament, dismantles existing regulator the Financial Services Authority (FSA) and hands most of the day-to-day regulation of and supervision of banks, building societies and insurers to a new Prudential Regulation Authority (PRA), also within the Bank of England. A new Financial Conduct Authority (FCA) will take on the conduct and compliance issues of the FSA.

In its letter the FPC has requested the ability to set the 'countercyclical capital buffer' under the international banking agreement known as Basel III, which will provide new baseline requirements for the both the quality and quantity of capital held by banks from its phased introduction beginning in 2013. This is the power which will be given to national regulators to order banks to raise or lower their capital buffers in certain circumstances. The FPC has also requested power over the Basel III leverage ratio, allowing it to limit the amount that banks are able to borrow as a percentage of their risk-weighted assets.

It has also advised the Treasury to give the FPC the power to vary sectoral capital requirements, which will enable it to target risks in specific areas more precisely than through the combined countercyclical capital buffer. It noted that the "over-exuberance" that had preceded previous financial crises had tended to emerge first in specific sectors, such as commercial and residential property.

The Government is due to consult on the full extent of the FPC's macro-prudential powers as part of the Parliamentary passage of the Financial Services Bill.

Industry body the British Bankers' Association (BBA) warned that the new regulator's complex responsibilities meant that the quarterly financial stability reports it will be required to publish must be "simple and transparent".

"[W]hile its equivalent on the monetary side – the Monetary Policy Committee – report on a single, specific indicator for monetary policy (the inflation rate) there is no similar, single indicator for financial stability" said the BBA's financial policy director, Paul Chisnall, on the industry body's blog. "The FOC will therefore be expected to exercise a greater degree of judgement when identifying possible threats to financial stability. As such, it will have a greater responsibility to explain any actions it considers necessary to prevent threats materialising."

Chisnall said that the FPC's greatest power would be its ability to "advise and influence, to anticipate potential risks to the economy". However, he added that it would have additional powers which could influence the structure of the market and affect the balance sheets of financial institutions and the terms and conditions of ordinary financial transactions.