The UK financial system is supporting the economy during the pandemic

UK households and businesses have needed support from the financial system to weather the economic disruption associated with Covid-19 (Covid). The financial system has so far provided that support, reflecting the resilience that has been built up since the global financial crisis, and the extraordinary policy responses of the UK authorities.

Businesses have raised substantial external financing since the start of the Covid pandemic from banks and financial markets, to help finance their cash-flow deficits. Households’ debt-servicing burdens have fallen during that period, supported by payment deferrals from lenders. The extension of the Coronavirus Job Retention Scheme has supported household incomes.

Although there have been encouraging developments on vaccines, the FPC, consistent with its remit, is focused on the range of downside risks that remain. These include risks that could arise from the evolution of the pandemic and consequent measures to protect public health, as well as from the transition to new trading arrangements between the European Union and the United Kingdom.

The outlook for financial stability

Banking system resilience

The FPC judges that the UK banking system remains resilient to a wide range of possible economic outcomes. It has the capacity to continue to support businesses and households even if economic outcomes are considerably worse than currently expected. This reflects the build-up of substantial buffers of capital since the global financial crisis.

Over the course of 2020, major UK banks’ and building societies’ (‘banks’) aggregate Common Equity Tier 1 capital ratio has increased to 15.8% at end-September, which is over three times higher than at the start of the global financial crisis. Over this period, they have provisioned for £20 billion of credit losses, although the effect on the capital ratio is reduced by the transitional relief of IFRS 9.

Some headwinds to banks’ capital ratios are therefore anticipated over coming quarters as unemployment rises, business insolvencies rise from current low levels, and risk weights on banks’ exposures increase. Nevertheless, the major UK banks can absorb credit losses in the order of £200 billion, much more than would be implied if the economy followed a path consistent with the MPC’s central forecast.

The FPC judges that the UK and global macroeconomic scenarios required to generate losses on this scale would need to be very severe with, for example, UK unemployment rising to more than 15%.

The FPC expects banks to use all elements of capital buffers as necessary, to continue to support the economy. Alongside the Prudential Regulation Authority (PRA), it is taking action to support the use of capital buffers.

The FPC is updating its guidance on the path for the UK countercyclical capital buffer (CCyB) rate. It now expects this rate to remain at 0% until at least 2021 Q4. Due to the usual 12-month implementation lag, any subsequent increase is not expected to take effect until 2022 Q4 at the earliest. The eventual pace of return to a standard 2% UK CCyB rate will depend on banks’ ability to rebuild capital while continuing to support households and businesses.

The FPC welcomes the PRA’s intention to return towards the standard framework for bank distributions. This reflects some reduction in the uncertainty related to Covid, and the ability of banks to withstand significant losses. The FPC recognises the importance of a stable and predictable capital framework which provides certainty to banks and facilitates the use of capital buffers where necessary.

Cutting support to the economy to avoid the use of capital buffers would be costly for the wider economy and consequently for banks themselves.

Stability in the provision of financial services at the end of the transition period with the EU

Financial sector preparations for the end of the transition period with the EU are now in their final stages. Most risks to UK financial stability that could arise from disruption to the provision of cross-border financial services at the end of the transition period have been mitigated. The mitigation of these risks reflects extensive preparations made by authorities and the private sector over a number of years.

However, financial stability is not the same as market stability or the avoidance of any disruption to users of financial services. Some market volatility and disruption to financial services, particularly to EU-based clients, could arise.

Market volatility could be reinforced in the event that some derivative users are not fully ready to trade with EU counterparties or on EU or EU-recognised trading venues. Financial institutions should continue taking measures to minimise disruption.

Irrespective of the particular form of the UK’s future relationship with the EU, and consistent with its statutory responsibilities, the FPC remains committed to the implementation of robust prudential standards in the UK. This will require maintaining a level of resilience that is at least as great as that currently planned, which itself exceeds that required by international baseline standards, as well as maintaining UK authorities’ ability to manage UK financial stability risks.

Developments in the UK mortgage market

Mortgage credit conditions remain tighter than at the start of the year, particularly for high loan to value mortgages. This reflects reduced risk appetite from lenders due to the economic outlook, as well as operational constraints in meeting the current high demand for mortgages.

The FPC’s mortgage market Recommendations limit the proportion of new mortgages with high loan to income ratios, guarding against an increase in the number of highly indebted households.

The measures are structural and intended to remain in place through cycles in the mortgage market. The FPC’s last review of its Recommendations in 2019 found no evidence that they were having a material impact on mortgage availability overall since they were introduced in 2014. That has remained the case since.

The FPC periodically reviews its measures, including their calibration. It judges that changes over time in the risks faced by households mean the measures warrant a further review. That is under way and the FPC will report its conclusions in 2021.

Ensuring the financial system is ready to serve the future economy

The supply of productive finance for companies

In order to help limit the degree of economic scarring caused by Covid, work to increase the supply of longer-term, equity-like financing is increasingly important. The Bank, with HM Treasury and the Financial Conduct Authority, has launched an industry working group to facilitate investment in productive finance.

Systemic stablecoins

Stablecoins are digital tokens that claim to maintain a stable value at all times, primarily in relation to existing national currencies. They could provide benefits to users but will be adopted widely and become successful as a means of payment only if they meet appropriate standards and confidence in their value is assured.

The FPC, along with many authorities internationally, is considering the potential effects on financial stability if stablecoins were to be adopted widely. A discussion paper on these issues will be published in due course by the Bank. That paper will also address issues that may arise in connection to the concept of a Central Bank Digital Currency — an electronic form of central bank money that could be used by households and businesses to make payments.

The FPC is also considering how the regulatory system should adapt to assure confidence in the value of stablecoins at all times, while supporting innovation, in an efficient way. Their users must be as sure of their ability to redeem their money in cash, at face value, at all times, as they are with private money ― commercial bank deposits ― that is in widespread circulation in the UK today.