Eurozone ‘mess’ is a risk to UK banks, Bank of England governor admits

King also warns banks may be providing ‘misleading picture of their financial health’ during first briefing from the financial policy committee The crisis enveloping the eurozone is a “mess” that poses the “most serious and immediate” risk to the UK banking system, Mervyn King warned on Friday as he called for banks to provide more information on their exposures in the region. In his new role of chairman of the financial policy committee (FPC), the new “guardian of the resilience of the UK financial system”, King also warned that banks may be providing a “misleading picture of their financial health” if they were not making big enough provisions for borrowers having difficulty repaying loans. So-called forbearance has taken place in up to 12% of mortgages including 30-80% in the commercial property sector. Bank shares led the FTSE 100 index lower amid fears of new bad debt losses by the sector and after King called on banks to build up more capital when financial conditions allowed rather than pay out dividends to shareholders or in bonuses to staff. “In good times, banks should retain more of those earnings rather than distribute them to shareholders or as compensation,” King said. King was asked whether the crisis gripping the markets – caused by fears that Greece may default – could spark a meltdown on the scale of the one caused by Lehman’s collapse. He replied: “I am not sure that the sovereign crisis now and what happened in the case of Lehman Brothers have much in common, other than the fact that it is a mess.” UK banks’ exposure to Greece directly was “remarkably small”, he said, but he warned that the bigger risk was a “crisis of confidence”. “There is always uncertainty about the scale of exposures… which counter-parties out there are the ones which are heavily exposed,” he said. “That uncertainty can lead at various points for funders of banks… to draw back and there can be a crisis of confidence in sentiment.” He said more data was needed about exposures to allay any unnecessary concerns. As governor of the Bank of England, he is automatically handed the chairmanship of the FPC, a key plank of the coalition’s response to the financial crisis. When legislation grants it new powers next year, the FPC is expected to be able to stop bubbles being created by, for example, forcing banks to hold more capital. It met for the first time last week and held the first of its quarterly press conferences on Friday, setting out the worry-list of its members, drawn from the Bank of England and the Financial Services Authority (FSA) along with four external members. All members were unanimous in setting out their first six recommendations intended to help tackle the threats to financial stability: • Permanently improve banks’ disclosure of sovereign and banking sector debt exposure. • Advise the FSA to compile the exposure of smaller banks which are not part of current EU stress tests. • Establish the forbearance practices of banks to households and corporates globally. • “Monitor closely” the risks of “opaque funding structures”. • Advise banks to build up their capital when they are profitable. • Advise the FSA to ensure banks set enough capital aside during profitable times. A record, rather than minutes, of the FPC’s meeting showed members discussed whether the FSA should set out a limit for the size of dividends and bonuses that can be paid out of earnings but they decided against any such clampdown. King, who will this weekend travel to a meeting of banking supervisors in the Swiss city of Basel to discuss global capital rules, called on the eurozone to “set out a very clear road map” for the solution to its debt crisis. In the opening paragraphs of its financial stability report, the FPC said: “Market concerns remain over fiscal positions in a number of euro area countries and the potential for contagion to banking systems. Any associated disruption to bank funding markets could spill over to UK banks.” The FPC illustrated its concern by highlighting the exposure of France and Germany to the eurozone: “In conditions of severe stress in the eurozone, this could increase the risk of losses to UK banks, given that their combined claims on France and Germany represented around 130% of their core tier one capital, with close to that accounted for by claims on banks.” King again stressed that he did not regard the crisis as one of liquidity but as one about solvency and “the buildup of very large amounts of debt where concerns crept in on the ability of the borrowers to repay that debt.” He warned that the FPC would not be able to prevent another catastrophe: “Focusing – as the FPC must – on risks to the financial system can leave one feeling rather depressed. We can’t hope to prevent financial crises from happening, but we can build institutions that help to ensure that our financial system is more resilient in the future.” Financial policy committee Financial crisis Global recession Banking European debt crisis European banks Bank of England Economic policy Jill Treanor guardian.co.uk

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