Watchdog looked at relaxing banks’ balance sheet rules

a NEW financial watchdog considered making life easier for banks by relaxing tough balance sheet rules in a bid to encourage lending, documents have reveal-ed.

The Financial Policy Committee (FPC) discussed whether banks could loosen their capital or liquidity ratios – cushions that protect banks when they hit choppy water.

But ultimately the FPC, set up to oversee the country’s financial stability after the credit crunch, judged it would be “inappropriate” to relax the rules as such a move could be perceived as weakening the banks’ funding positions, which in turn could lead to lower lending.

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Banks should instead “take any opportunity” to bolster balance sheets, including cutting dividends and bonuses, the FPC concluded.

The FPC, an official committee of the Bank of England, chaired by the Bank’s governor Sir Mervyn King, currently meets on an interim basis before it is given full legislative powers next year.

Eurozone debt fears have made it harder for banks to hoard cash to prepare for the shocks ahead without choking off lending to households and firms, the Financial Policy Committee (FPC) said. The FPC, as a result, discussed whether there were short-term measures to offset these risks, including lowering capital buf- fers.

The minutes, from the September 20 meeting, said: “The committee discussed whether it could signal that, while it would not welcome a reduction in levels of bank capital or liquidity, it would be content for ratios to fall if that were driven by an increase in lending to the non-financial sector.”

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The committee said some members believed banks’ liquidity buffers could be allowed to fall “without dangers to market confidence” but for others such a move could “undermine the ability of banks to maintain funding and, thereby continue to support credit supply”.

In its first meeting in June, the FPC said banks should build up cash levels when earnings are strong – but in its most recent meeting admitted this may not be possible given current risks to the economy.

The committee said banks should bolster their resilience to future crises in other ways, including adjusting “discretionary distributions” – in other words bonuses and dividends – to reflect any drop in profits.

The FPC also advised the Financial Services Authority (FSA), which it is set to supersede, to encourage banks to manage their balance sheets in a way which would not worsen the economic climate.

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Elsewhere, the committee said it will continue to debate which tools it will need to promote financial stability once its powers are finally established.

The September meeting came after the International Monetary Fund (IMF) warned that the eurozone debt crisis had added 300 billion euros (£260bn) to the risk exposure of EU banks.