The Bank of England said improvements in the global economy is lagging behind markets as it warned that investors may be underestimating risks in the financial system.
Gains by equities since mid-2012 “in part reflected exceptionally accommodative monetary policies by many central banks,” the BOE’s Financial Policy Committee said today in London in the minutes of its March 19 meeting. “It was also consistent with a perception among some contacts that the most significant downside risks had attenuated. But market sentiment may be taking too rosy a view of the underlying stresses.”
At the meeting, the FPC recommended that U.K. lenders raise 25 billion pounds ($38 billion) of additional capital to cover bigger potential losses on commercial real estate and from the euro area, possible fines for mis-selling and stricter risk models. While banks have strengthened their resilience in recent years, the FPC said today that not all of them may be able to withstand unexpected shocks and maintain lending.
The FPC discussed potential threats from the crisis in Cyprus, which agreed on an international bailout last month. While at the time of the March 19 meeting there were “minimal signs” of spillovers to other financial systems, there was “a risk that this situation could change,” the committee said.
In making its recommendation, the FPC said that “a line needed to be drawn under doubts about U.K. banks’ capital adequacy.” It said that in light of the latest decree, further recommendations on capital shouldn’t be necessary “in the immediate future.”
Still, the FPC noted the potential threats to the financial system from increased risk appetite among investors.
“This was evident in the re-emergence of some elements of behavior in financial markets not seen since before the financial crisis, including a relaxation in some U.S. credit markets of non-price terms and increased issuance of synthetic products,” the committee said. “At this stage, they did not appear indicative of widespread exuberance in markets. But developments would need to be monitored closely.”
The FPC also said that banks’ leverage ratios, a measure of their debt to equity level, would remain “very high” even after the new recommendations were met. It said there would be “little margin for error against a backdrop of low growth in the advanced economies.”
It said the Prudential Regulation Authority -- which took over from the Financial Services Authority this week -- should take leverage ratios into account when determining individual bank capital requirements. The FPC didn’t name any banks.
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