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The Financial Policy Committee might want to limit mortgages

The Bank of England body admits it is too soon to allow banks to reduce their capital ratios

The new guardian of financial stability, the Financial Policy Committee, provided a few more clues on Monday to the types of “levers” it would like to pull when markets are overheating – such as limiting the size of mortgages.

The record – rather than the minutes – of its second meeting on 20 September also show that the committee discussed the measures that might be needed to bolster economies when they are slowing down – just as they are now. But, after what looks to have been a lengthy discussion, the committee decided that …

the balance of opinion on the committee was that it would be inappropriate in current circumstances for banks to reduce capital or liquidity ratios.

The committee was clearly concerned about the impact the turmoil in the eurozone – described as “severe strains in financial markets” by the members – would have on the supply of credit if banks found it difficult to raise cash or hoard capital.

One consequence of the strains in financial markets had been the virtual closure to banks of public term unsecured funding markets … There had also been growing signs of impairment of shorter-term interbank funding markets in Europe, especially in US dollars, which had prompted the announcement of additional US dollar liquidity-provision operations by central banks.

Although UK and other EU banks had already met a significant proportion of their anticipated funding needs for the year, they might begin to dispose of assets or reduce the availability of lending if they expected their access to funding markets to remain impaired for a significant period or if the maturity of money market placements continued to shorten.

Market intelligence suggested that some tightening in lending standards had already begun, or was about to begin, across a number of banks in Europe. A further tightening of credit conditions could lead to an adverse feedback loop between weaker activity and a deterioration in credit quality, both in the United Kingdom and the euro area.

The discussion about the types of “levers” – officially known as macroprudential instruments – demonstrates that the committee is looking at direct ways to limit capital and liquidity requirements for banks, and crucially does not want the European Union to get in the way should it decide it needs to impose tougher standards than the European minimum.

Some of its tools come in the form of putting restrictions on lending. So while the committee might want to restrict the loan-to-value at which mortgages can be sold, it might also want to alter the risk it attaches to new and old lending by banks to influence the amount of capital banks need to hold.

Interestingly, the committee appears to feel that restricting the size of mortgages relative to income should be used as a last resort.

Some members thought that such tools might best be used after other steps had been tried. Members also felt it would be important to have tools that influenced financing conditions in a wider set of markets, for example margining requirements.

The committee will not get any of these tools until next year so it is still something of a “wish list” that will be discussed again in its meetings next year. The committee noted that it was likely to need to review its list of “instruments” over time and that, for time being at least, was likely to ask for only a few levers as in turn these might create new issues for the committee to consider.

As such, it was minded to recommend initially a relatively narrow set of instruments for directive powers, which could evolve over time. Furthermore, it was clear that innovation and change within the financial system would give rise in due course to new risks to which the committee would need to respond. © 2011 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds