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(Updates with comment from analyst in seventh paragraph.)
Sept. 28 (Bloomberg) -- The Bank of England’s Financial Policy Committee said market strains related to the euro-area debt crisis have dented the outlook for bank earnings and may impede their ability to strengthen balance sheets.
“The committee had advised U.K. banks in June that if their earnings were strong, they should seek to build capital levels further,” it said in London today. “But events had lowered the likelihood that banks would be able to strengthen their balance sheets in this way over the short term.”
Finance ministers and central bankers at the International Monetary Fund’s and World Bank’s annual meeting last week urged European officials to intensify efforts to contain the region’s debt crisis amid the specter of a Greek default. Today’s FPC report recommended that banks take “any opportunity” to strengthen capital and liquidity.
“This could include raising long-term funding whenever possible and ensuring that” any profit decline is reflected in “discretionary distributions” such as pay and dividends, according to the report. In the event of a shock, it “would be natural for banks’ capital and liquidity ratios to be run down to ensure that lending” isn’t constrained.
The interim FPC, which met Sept. 20, also said there have been “severe strains in financial markets” since its last meeting in June.
These “stemmed in large part from continuing concerns” about debt levels in some nations, the committee said. “Anxiety about the consequences of these issues for banks had increased materially and, in turn, the perceived vulnerabilities of banks were adding to strains.”
“It leaves the door open for rights issues,” said Cormac Leech, an analyst at Canaccord Genuity Ltd. in London. “Essentially the Bank of England is saying, ‘we want you to keep lending to the real economy; if you’re not able to do it, run your capital ratios down and raise more capital.’”
The IMF said in a report this month that the euro-region crisis has left European lenders with as much as 300 billion euros ($408 billion) of credit risk. The Bank of England said in a separate report today that lenders in a survey “pointed to adverse wholesale conditions as a key factor which might constrain future lending.”
The FPC met 12 days after the bank’s Monetary Policy Committee voted to maintain the key interest rate at a record low and leave its bond-purchase plan unchanged. Most MPC officials said it was “increasingly probable” that more stimulus may be needed to bolster the recovery.
“This announcement by the FPC is a good illustration of how macroprudential policy is viewed as a useful complement to monetary policy,” said Simon Hayes, an economist at Barclays Capital in London and a former central bank official. “The Bank of England now has a vehicle for more direct intervention in credit markets, taking some of the pressure off monetary policy for controlling the credit cycle.”
Royal Bank of Scotland Group Plc swung into a loss in the first half on writedowns on Greek debt and costs for compensating insurance clients. Barclays Plc said last month it plans to cut about 3,000 jobs this year after second-quarter investment banking profit fell 27 percent amid a “difficult operating environment.”
Europe’s Stoxx 600 Index fell 0.3 percent as of 12:47 p.m. in London. It has tumbled 22 percent from its 2011 high on Feb. 17. The Bloomberg Europe Banks and Financial Services Index fell 1 percent, taking its decline this year to 30 percent.
The FPC, part of a regulatory overhaul by Britain’s government, said it will continue to debate which tools it will need to promote financial stability once its powers are finally established. It said it may need power over the balance sheets of financial institutions, terms and conditions of some transactions and market structures.
Among the tools it considered were maximum leverage ratios, countercyclical capital and liquidity buffers, limits on loan- to-value ratios and disclosure requirements. The FPC is due to report to the U.K. Treasury in the first half of 2012 and said today it may initially recommend a “relatively narrow” set of tools that could be broadened over time.
In its Credit Conditions Survey, the Bank of England said that the availability of secured credit to households increased in the three months to early September and lenders expected availability to increase a “little further” in the coming three months. Demand for such loans also increased.
Lenders in the survey reported that default rates on mortgages fell in the last three months and were expected to be unchanged in the coming quarter. The survey was conducted from Aug. 16 to Sept. 7.
--With assistance from Howard Mustoe in London. Editors: Fergal O’Brien, Jeffrey Donovan
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