Out-Law / Your Daily Need-To-Know

Banks should consider raising external capital due to “exceptionally threatening” conditions, Bank of England says.

05 Dec 2011, 12:58 pm

Banks should begin limiting dividend payouts and give serious consideration to raising external capital reserves in the coming months if they cannot build up reserves from their earnings, an influential banking committee has warned.

The Bank of England’s interim Financial Policy Committee (FPC) recommended the action in its December Financial Stability Report due to the “current exceptionally threatening environment” caused by the crisis in the eurozone, it said.

However banks must take the action to improve the resilience of their balance sheets “without exacerbating market fragility or reducing lending to the real economy”, it warned.

Presenting the report at a press conference in London Sir Mervyn King, Governor of the Bank of England, said that “tackling the symptoms of the crisis without resolving the underlying causes” by providing extra liquidity to banks would only offer “short-term relief”.

The FPC’s responsibility was, King said, to “focus on measures that can protect and enhance the resilience of the UK financial system in this threatening environment”, and to ensure that the country was better equipped to deal with more serious future problems such as the potential collapse of the euro.

He did, however, stress that UK banks were “better capitalised” than their European equivalents.

King was criticised in the aftermath of the speech by banking and business representatives who told weekend newspapers that his comments risked undermining market confidence.

The report said that one way for UK banks to gain further strength would be to raise money by issuing new shares. However, it also suggested that banks cut dividends and bonuses in order to help build up their financial reserves.

Tony Anderson, a banking law specialist with Pinsent Masons, the law firm behind Out-Law.com, said that this was a “circular issue”.

“It is difficult to see investors being attracted to new share issuances from UK banks when the FPC is simultaneously advocating that banks should cut dividends,” he said.

The FPC also recommended that banks disclose their leverage ratios, or the percentage of capital they hold in relation to their risk-weighted assets, before they are required to do so by the Basel III international banking agreement from 2015. It did so “given its potential usefulness to investors”, King said.