Bank of England Says Financial System Vulnerable to More Shocks 

June 26, 2009 (Bloomberg) -- The Bank of England said financial institutions’ 
losses from the crisis have left them vulnerable to another wave of shocks, 
including the risk that the economy will stay mired in recession. 

“Given their leverage and funding positions, banks in the United Kingdom and 
internationally will remain sensitive to further shocks for some time,” the 
central bank said today in London. “If economic recovery were to stall as a 
result of weak bank lending, losses on assets could rise, further affecting 
confidence in the banking sector.” 

The bank’s biannual financial stability risk assessment follows Governor Mervyn 
King’s comments that banking problems may make the economy’s escape from 
recession a “long, hard, slog.” The report today also makes suggestions on 
regulation changes including greater capital buffers for institutions days 
before the Treasury unveils its own proposals for a revamp. 

“Banks’ balance sheets remain sensitive to any setbacks in recovery in 
financial markets or real activity,” the bank said. “The economic downturn is 
still perceived by market participants as the highest risk to financial 

Only 15 percent of banks said they are “very confident” in the financial 
system’s stability in the next three years, compared with 36 percent in July 
2008, a survey of 34 institutions in the report showed. They cited an economic 
slump and borrower defaults as the biggest risks. Responses were collected from 
April 27 to May 15. 

Bank Losses 

U.K. banks’ loan book losses have now reached almost 400 billion pounds ($654 
billion), the bank said, without giving a forecast. The European Central Bank 
said last week that lenders in the 16-nation euro region may lose a further 
$283 billion by the end of next year. 

“While pressures on the major global banks have stabilized over the past few 
months, their balance sheets remain impaired,” the Bank of England said. 
“Rising household and corporate distress, and continuing falls in property 
prices, raise the possibility of further asset impairment.” 

More losses risk adding further pressure to banks’ profitability and capital 
ratios, the bank said. 

“Future revenue generation will need to balance the desire to de-leverage with 
the need to generate new business at profitable spreads,” the bank said in its 

The global financial system is also vulnerable to shocks from lenders 
repatriating their financing in foreign countries, the report said. U.K. banks 
had to weather the withdrawal of about $100 billion of deposits to Russia in 
the fourth quarter. 

Payout Liability 

In the “highly unlikely event” that the British government had to pay out on 
all emergency guarantees and insurance facilities offered to banks, the total 
liability would be $2.1 trillion, or 88 percent of gross domestic product, the 
BOE said. That compares with 73 percent in the U.S. and 18 percent in the euro 

The Bank of England, suggesting changes to financial regulation, said lenders 
should be required to provide their own insurance from shocks by building up 
capital buffers with common equity and liquidity buffers with high-quality 
government bonds. It said they also need plans to obtain funding in times of 
stress and to wind down their operations in case of failure. 

Banks should also boost disclosure of the value of the assets they own and give 
more details of their stress test and sensitivity analyses, the central bank 

“Greater resilience will need to be based on a variety of measures,” Paul 
Tucker, deputy governor for financial stability at the bank, said in a 
statement. “The policy debate now under way matters enormously if we are to 
achieve a more stable financial system in the future.” 

Global Regulation 

The report urged international regulators to cooperate more closely to manage 
risks posed by global financial institutions, whose cross-border claims have 
almost doubled in the past decade. Regulators must ensure they can monitor such 
firms while preventing them from becoming too big or complex, the bank said. 

The bank still expressed a note of optimism that the slump may have past its 
worst after the U.K. economy contracted 1.9 percent in the first quarter, the 
most since 1979. Banks’ funding conditions are improving as capital markets 
reopen and interest rates fall, the report said. 

“In recent months, market conditions have improved and there are signs that the 
pace of decline in gross domestic product is easing,” the bank said. “Some 
markets that had been effectively closed to all but the strongest institutions 
appear to be reopening.”


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