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Bank of England moves to head off pre-crisis signals

The Bank of England has warned retail lenders to bulk up capital reserves by the end of 2018. As UK household indebtedness grows, the bank's governor warned lenders against "forgetting the lessons of the past."

The BoE is increasing what is called the countercyclical capital buffer rate from zero percent to 0.5 percent, the BoE's Financial Policy Committee (FPC) watchdog said in its bi-annual report issued on Tuesday.

The move takes immediate effect and puts the target figure at £11.4 billion ($14.5 billion, 12.9 billion euros), with the FPC expected to increase the rate to 1.0 percent in November, with binding effect a year later.

This is the cash banks keep in reserve to handle crises, the likes of which the global banking system experienced in 2008-9.

Consumer credit is growing at around 10 percent a year, a pace not seen since before that financial crisis and the move is widely seen as precautionary in light of rising inflation, a possible hike in rates and the impact of this on the main driver of the UK economy, consumer demand.

The extra capital buffer will mean UK banks must meet a 4 percent leverage ratio, Mark Carney, the governor of the BoE, said.

With a current leverage ratio of 5.25 percent, banks shouldn't face a massive challenge meeting the demands, he added, although warned that: "The banks are not gaming the system, but they're not learning the lessons of the past," Carney said.

After the UK decided to leave the EU a year ago, the FPC cut to zero the requirement that banks create an extra capital buffer. This was part of a range of stimulus measures to help cope with the shock.

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"The increase to 0.5 percent will raise regulatory buffers of common equity Tier 1 capital by £5.7 billion," the report said. "This will provide a buffer of capital that can be released quickly in the event of an adverse shock occurring that threatens to tighten lending conditions."

Bank of England governor Mark Carney.

Bank of England governor Mark Carney.

Warning signs

Carney cited the sharp build up in car financing – both in volume and the move towards ‘personal contract purchasing' deals (where buyers pay monthly repayments).

He said Britain's banking sector was strong, and "significantly" more resilient since the financial crisis of almost a decade ago, but also warned that consumer credit for cars had jumped by 10.3 percent in the year to April. [this was] "markedly faster than nominal household income growth," the report noted.

Auto Hand Hände (Fotolia/Helder Almeida)

The car purchasing market is overtaking the capacity of borrowers to repay their loans.

We're forever blowing bubbles

Carney said the boom in car loans is a major factor behind the pick-up in consumer debt, but that he remained "sanguine” about the banking sector's overall exposure to it.

The report in in particular noted the car market, following the boom in "Personal Contract Purchase” deals, which allow customers to pay a monthly fee for a new car, and then either pay a large ‘balloon payment' to own it or switch to a new deal with a new vehicle.

"The growth of such deals over the past few years has been astronomical and the level of consumer debt this is causing is getting out of hand," Alex Buttle, director of car buying website Motorway.co.uk, told the Guardian.

"The problem is that household finances are starting to get stretched and many people are probably living beyond their means because of readily available credit, including car loans," Buttle said.

In the hosuing market Carney said Britain has "very low risk-free rates, and high valuation levels." So either those rates should rise, or asset prices should fall.

Several property funds froze redemptions after the EU referendum, to stop investors cashing out, exposing the dangers of investing in ‘illiquid assets' such as shopping centers]

The report called on banks to tighten affordability tests for home loans.

"Consumer credit has increased rapidly," it said. "Lending conditions in the mortgage market are becoming easier. Lenders may be placing undue weight on the recent performance of loans in benign conditions," it added.

Dangers of a growing economy

The economy has performed more strongly than expected since the referendum, despite some recent signs of a slowdown. Inflation is above the BoE's target at 2.9 percent and is set to rise higher as the pound's fall since last year's Brexit vote feeds through into prices.

This in turn puts pressure on the BoE to raise its main interest rate from a record-low 0.25 percent. Some of the central banks' interest rate setters now think it is time to raise its main interest rate.

Andy Haldane, BoE's chief economist, said he might vote for a rate hike in the second half of the year if the economy continues to grow at a steady pace. This followed three out of eight policymakers on the Monetary Policy Committee (MPC) voting to hike rates, highlighting the biggest split on the council since 2011.

Carney said the FPC's action did not in itself imply that monetary policy was also about to tighten.

"Monetary policy is the last line of defense to address financial stability issues," Carney told a news conference. "In that regard, we don't need monetary policy to do our job. In fact, by doing our job we allow monetary policy to focus on its job which is returning inflation sustainably to target in an exceptional period."

Bank shares fell after Tuesday's BoE announcement but quickly recovered to their levels earlier on Tuesday.

US regulators

Carney said the BoE had had "very productive discussions" with US regulators. He said it was important to have open global standards and even more important that they are implemented, to avoid another financial  crisis.

Donald Trump has vowed to cut regulations in the financial sector, such as the Volcker rule which is meant to prevent banks taking dangerous trading risks. Trump is also keen to repeal Dodd-Frank, which was brought in after the financial crisis.

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jbh/rd (Reuters, AFP)

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