BoE says banks should tighten buy-to-let lending standards

The Bank of England said banks should begin building up capital earmarked to support lending when the economy turns down, as the outlook for UK financial stability worsens.

The BoE's Financial Policy Committee raised the countercyclical capital buffer rate for U.K. exposures to 0.5 percent of risk-weighted assets from zero, becoming binding from March 29 next year. The buffer applies to UK banks and building societies, as well as to branches of other European Union banks that lend into the country.

"Risks associated with domestic credit are no longer subdued," and global risks "which can also affect UK exposures indirectly, are heightened," the FPC said in explaining its decision. The June 23 referendum on the UK's membership of the EU is the source of "the most significant nearterm domestic risks to financial stability," the regulator said in a statement.

The BoE said it intends to set the countercyclical capital buffer at about 1 percent in a "standard risk environment." The aim of the measure is to push against banks' tendency to boost lending in boom times only to slash it in a bust, exacerbating damage to the economy.

The central bank also wants to use the buffer to help simplify its capital requirements and make them more transparent.

Toward this end, overlapping elements of existing bank-specific capital buffers will be reduced, "where possible," by 0.5 percent as the countercyclical buffer is increased, the FPC said. As a result, "banks accounting for around three quarters of the outstanding stock of U.K. lending will not see their overall regulatory capital buffers increase," the regulator said. This is a "one-off adjustment reflecting the transition to the new capital framework," it said.

A countercyclical leverage ratio buffer will be set at 35 percent of the riskweighted buffer, applying only to big U.K. banks and building societies. "The bank is creating room on the downside, space that can be used if there's a Brexit, for example," Philip Rush, U.K. economist at Nomura International Plc in London, said before Tuesday's decision. "It's basically a neutral reallocation of capital within the current structure. There are some large financial imbalances in the U.K. economy that could correct if there's a Brexit."

On risks to stability from the EUmembership referendum, the FPC said the effect so far "has been most marked in sterling spot and options markets," and "heightened and prolonged uncertainty has the potential to increase the risk premia investors require on a wider range of UK assets." The FPC said some market developments "motivate careful review" and consideration of possible changes to international rules to promote "market effectiveness."

"Some measures of liquidity, such as bid-ask spreads, do not suggest deteriorating conditions," the FPC said. "However, the Committee also places weight on indications of lower market depth, smaller trade sizes on average and greater price impact of asset sales."

Officials plan to feed the results of stress tests, which the banks undergo annually, into the calculation of buffer rates. The BoE published the key elements of its 2016 stress test, which is applied to banks and building societies with total retail deposits of more than 50 billion pounds.