The Bank of England set out plans on Tuesday to require banks to hold as much as 10 billion pounds extra capital as the credit cycle moves into a more normal phase, but stopped short of immediate action. The central bank said credit conditions in Britain had largely recovered from the financial crisis as banks began to lend more freely, and warned that asset prices were vulnerable to a big rise in interest rates and emerging market risks. "Following the global financial crisis, there was a period of heightened risk aversion and retrenchment from risk-taking," the BoE said. "The system has now moved out of that period." The central bank said it now expected banks to hold a so-called counter-cyclical capital buffer (CCB) of 1 percent during normal times, and was in the process of tweaking bank-specific requirements with a view to impose this step-by-step from March. The CCB aims to rein in risky lending at frothier stages of the credit cycle. It stands at zero currently, but the BoE has already required some banks to hold extra capital due to firm-specific risks. Some economists and banking analysts had expected the BoE to raise the CCB this month to 0.5 percent. The BoE also said it expected the banking sector as a whole to hold high-grade tier one equity capital of 13.5 percent of risk-weighted assets by 2019, up from 13 percent now -- part of which would overlap with the capital required for the CCB. The BoE has said it wanted to give banks more clarity about its long-run aims for the amount of capital they hold, now that credit conditions had largely got back to normal. Banks have complained that in the past, the BoE has unexpectedly piled on extra capital requirements, making it hard for them to lend or decide which lines of business to stay in. Alongside its half-yearly Financial Stability Report, the BoE also released the results of annual 'stress tests' into how lenders would deal with unexpected economic shocks. This year the focus was on emerging market and trading risks, and Royal Bank of Scotland (RBS.L) and Standard Chartered (STAN.L) both only passed thanks to steps they took to improve their capital ratios mid-way through the testing process. The other five big lenders tested -- HSBC (HSBA.L), Barclays (BARC.L), Lloyds Banking Group (LLOY.L), Santander (SAN.MC) and Nationwide -- did not have to take action. Asset managers will face tests next year of how they would deal with investors pulling out their money en masse. HIGHER RATE RISK The BoE Financial Policy Committee's report comes as markets brace for the United States to raise interest rates later this month for the first time since the financial crisis. "Financial market prices remain vulnerable to a sharp increase in market interest rates or the compensation demanded by investors for risky assets," the report said. With the BoE's Monetary Policy Committee unlikely to raise British interest rates until later next year, the FPC is having to take other steps to guard against risky behavior. Even if domestic cost pressures are too weak to warrant a rate rise, British consumer and mortgage lending is growing at its fastest rate since the financial crisis. So-called buy-to-let mortgages -- which enable small landlords to purchase property to rent out -- showed weaker underwriting standards than residential mortgages and the BoE's Prudential Regulation Authority said it was examining this. The FPC said it still stood ready to take action if needed and would monitor closely the impact of higher property transaction taxes for buy-to-let which finance minister George Osborne announced last week and will take effect next April. The BoE also said a recent narrowing in Britain's big current account deficit was likely to be temporary, and that vulnerabilities could build quickly. Source: Reuters
