The UK is taking
all the action it can to make sure households and businesses won’t have their
financial services disrupted during Brexit. The EU needs to act to stop
households and businesses there and in the UK facing disruption.
The FPC is concerned by the rapid
growth of risky lending to businesses.
Emerging market debt has risen in
the past decade. This makes those economies, and the world economy, riskier.
Policy Committee Statement from its policy meeting, 3 October 2018
Financial Policy Committee (FPC) aims to ensure the UK financial system is
resilient to, and prepared for, the wide range of risks it could face — so that
the system can serve UK households and businesses in bad times as well as good.
meeting on 3 October, the FPC reviewed developments since its meeting on 19
to UK financial stability from Brexit
The FPC continues to judge that the UK banking system would
be strong enough to serve UK households and businesses through a disorderly,
The UK banking system lies at the core of the UK financial
system. Reflecting the substantial increase in its resilience over the
past decade, the UK banking system now has the capacity to absorb, in addition
to a disorderly, cliff-edge Brexit, further misconduct costs and stresses that
could arise from intensifying trade tensions and a further sharp tightening of
financing conditions for emerging markets.
- Consistent with its remit to ensure the financial
system is resilient to major shocks, the FPC continues to review estimates of
possible ‘worst case’ economic outcomes associated with Brexit, however
unlikely they may be.
- The FPC continues to judge that the 2017 stress test
encompassed an appropriately wide range of UK macroeconomic outcomes that could
be associated with Brexit. As it has set out previously, the FPC judges
that Brexit risks, including those of a disorderly, cliff-edge Brexit in which
there was no agreement or implementation period, do not warrant additional
capital buffers for banks.
- The 2017 stress test scenario included the UK
unemployment rate rising to 9.5%, UK residential property prices falling by 33%
and UK commercial real estate prices falling by 40%. It also included a
sudden loss of overseas investor appetite for UK assets, a 27% fall in the
sterling exchange rate index and Bank Rate rising to 4%.
- At 16.8%, the aggregate Tier 1 capital ratio of the
major UK banks is around three times that of ten years ago. Losses on a
scale that would have wiped out the common equity capital base of the system in
2007 can now be readily absorbed by available capital.
An implementation period would reduce the risks of
disruption to the supply of financial services to UK and EU households and
businesses as the UK exits the EU. The FPC has been monitoring risks of
disruption that could arise in the absence of an implementation period or any
other agreement (see the updated checklist in Table 1). There has been
considerable progress in the UK to address these risks, but only limited
progress in the EU. In the limited time remaining, it is not
possible for companies on their own to mitigate fully the risks of disruption
to cross-border financial services. The need for authorities to complete
mitigating actions is now pressing.
- The UK government is taking forward legislation that
will allow UK households and businesses to continue to access financial
services provided by EU companies. That legislation needs to be passed by
Parliament prior to Brexit to be effective.
- EU or member state rules will restrict EU households
and businesses from continuing to use some financial services provided by UK
firms. In some cases, particularly in insurance, UK financial companies
are restructuring so they can continue to serve their EU customers post
Brexit. However, actions by firms alone can be only partially
- Timely action by EU authorities is needed to mitigate
risks to financial stability, particularly those associated with derivative
contracts and the transfer of personal data.
- Absent action by EU authorities, EU rules create legal
uncertainty about whether EU clearing members could continue to meet their ongoing
obligations to UK CCPs and about the consequences for UK CCPs of continuing to
provide services to the EU. To ensure the safe operation of CCPs and
avoid financial stability risks, particularly in a stress, the contracts EU
clearing members have with UK CCPs will need to be closed out, or transferred,
before March 2019. This will be costly to EU businesses and could strain
capacity in the derivatives market.
Irrespective of the particular form of the UK’s future
relationship with the EU, and consistent with its statutory responsibility, the
FPC will remain 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.
outlook for UK financial stability and the UK countercyclical capital buffer
FPC continues to judge that, apart from those related to Brexit, domestic risks
remain at a standard level overall.
- Levels of household and corporate debt in the UK
relative to incomes remain materially below their 2008 levels but remain high
by international and historical standards. However, debt servicing burdens
- Over the past year, the debt of UK households and
businesses has grown only a little faster than nominal GDP.
The risk appetite of creditors remains strong. But
financial conditions have tightened over the course of the year and borrower
demand has been restrained. As a consequence credit growth has slowed.
financing conditions have tightened, they remain accommodative for large
companies. The extra compensation investors demand for the market and
credit risk in corporate bonds is compressed.
stock of bonds issued by UK companies has increased by around 3% in the past 12
months. Borrowing by UK companies from UK banks has also been subdued,
rising by just 2.7% in the past year.
the mortgage market, the additional interest rate charged on a 90% LTV mortgage
compared to a 75% LTV mortgage has compressed and the proportion of new
mortgage lending at LTV ratios above 90% has further increased to 17.8% in 2018
these very attractive terms, household mortgage borrowing increased by only
3.1% in the year to August, broadly in line with household disposable income
growth. Soft demand may reflect affordability challenges and uncertainty.
- The Committee is concerned by the rapid growth of leveraged
lending, including to UK businesses. The FPC will assess any implications
for banks in the 2018 stress test and also review how the increasing role of
non-bank lenders and changes in the distribution of corporate debt could pose
risks to financial stability.
- The global leveraged loan market is larger than
– and growing as quickly as – the US subprime mortgage market was in
2006. The Committee is reviewing the implications for UK financial
stability more intensively, even though it recognises that there are important
differences between these two markets, for example with less reliance now on
short-term wholesale funding.
- In common with the US and Europe, high investor demand
has driven strong growth in UK leveraged loans. Lending terms have
loosened with the proportion of UK leveraged loans with maintenance covenants
falling from close to 100% in 2010 to around 20% currently. Gross
issuance of leveraged loans by UK non-financial companies reached a record
level of £38 billion in 2017 and a further £30 billion has already been issued
in 2018. Taking high-yield bonds and leveraged loans together, the
estimated stock of debt outstanding in UK non-investment grade firms is now
estimated to account for about 20% of total UK corporate sector
- Leveraged loans are typically sold to non-bank
investors (including to collateralised loan obligation funds), whose ability to
sustain losses without materially impacting financing conditions is
uncertain. However, banks retain some exposure and make other loans to
the same highly indebted companies. The FPC is therefore assessing the
implications of rapid growth of leveraged lending for both non-banks and
Given the current balance of risks, the FPC is maintaining
the UK countercyclical capital buffer (CCyB) rate at 1%. The FPC will
conduct, as normal, a comprehensive assessment of the resilience of the UK
banking system in the 2018 stress test and review the adequacy of the 1% CCyB
rate at its meeting on 28 November.
Risks to the UK from global vulnerabilities remain
material. Accordingly, the 2018 stress scenario incorporates a synchronised
global downturn in output growth.
- The tightening of US monetary policy that began in
December 2015 has begun to contribute to a tightening in global financial
conditions, particularly over the past six months in emerging market economies.
- The most acute market pressures to date have focused
on Turkey and Argentina, which have large current account deficits and high
levels of debt. But a more widespread change in risk appetite could
expose broader vulnerabilities, including for other emerging market economies
with high debt levels and large current account deficits.
- The imposition of trade barriers by the US and China,
although detrimental to the outlook for global growth, does not itself pose a
material risk to UK financial stability. But deepening tensions could
trigger a further and more severe tightening of global financial
conditions. They could also encourage China to ease domestic financial
conditions and, in doing so, encourage a further build-up of risks.
- Recent further increases in Italian government bond
yields underline the vulnerabilities created by high public debt levels and
interlinkages between banks and sovereigns in the euro area.
- Risks from the US corporate sector remain material, as
leverage has continued to increase and underwriting standards have loosened
2019 biennial exploratory scenario
Recognising the deployment of resources both within the
Bank and at private institutions to prepare for Brexit, the FPC and PRC have
decided to delay the Bank’s launch of the next biennial exploratory scenario to
September 2019. The Bank expects to publish the results of this
exercise alongside the Financial Stability Report in June 2020.
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