Report warns many will struggle to keep up repayments as Bank deputy says global market movements an amber light for stability
Households could be forced to cut spending or work longer hours to keep up their debt repayments if interest rates rise suddenly. The warning from the Bank of England came as it called for an urgent assessment of the impact from a sharp rate increase after four years of low borrowing costs.
The Bank also used its financial stability report to give banks permission to release £70bn of easy-to-sell instruments, such as government bonds, which they have been forced to hold in case there is a re-run of the 2007 credit crunch. Paul Tucker, the outgoing deputy governor for financial stability, said it would be "foolhardly" to predict how much of the £70bn of liquidity being released might feed through into lending. But, he said, the relaxation of the rules would "strike the appropriate balance between achieving resilience and reducing possible impediments to the supply of credit to the economy".
The report made six recommendations intended to avert another banking crisis including calling on the Treasury to examine whether banks are ready for a cyber-attack and make banks reassess the way they measure risks.The first recommendation in the report, used by the new financial policy committee (FPC) to spot the next big risks to the financial system, focused on the impact of rising interest rates. Financial markets have already been spooked by concerns that the Federal Reserve might start to reduce the $85bn (£55.3bn) a month stimulus being pumped into the US economy with traders pointing to faster than usual rises in government bond yields.
"The violence of the adjustment over the past fortnight underlines the search for yield over the past months and the need for the authorities ... to pin down whether or not there are any vulnerable links in the financial system that could jeopardise stability," Tucker said. The current market movements were an amber light warning for stability, he added.
The Bank's governor, Sir Mervyn King, said on Tuesday that financial markets had "jumped the gun" on expecting a rise in global rates, although the Bank said that banks could be affected by rate rises as they price 40% of their assets on market values, which are falling.
"A significant cohort of UK borrowers could experience financial difficulties if interest rates were to rise during a period of subdued income growth," the Bank said. It cited a survey showing that households with the equivalent of 9% of mortgage debt, who replied to the survey, would have to take action, such as reducing spending or working longer hours, if rates were to rise by just one percentage point, from 0.5% currently, without an increase in their income. This would rise to 20% if interest rates were to rise by two percentage points.
The report pointed out that for the bulk of the six months since the Bank's last assessment of financial stability the markets had been stable and bank balance sheets had strengthened. But more recently volatility has increased because of concerns that interest rates could rise. This triggered the call by the Bank for regulators to report back to the FPC by September about the vulnerability of borrowers and financial institutions to "sharp upward movements in long-term interest rates and credit spreads".
The report said that financial stability was still "clouded by risks from a weak and uneven global recovery, and imbalances in the euro area".
"In the near term the risks could crystallise if global long-term interest rates were to rise abruptly from current still historically low levels, or credit spreads were to widen. Further out, risks could accumulate if a search for yield intensifies and assets become progressively mispriced," the report said.
Another recommendation requires banks to make an assessment of how much capital they needby using a standardised approach to measure risks, and not just their own models, which could force banks to hold more capital as well.
The FPC, which has faced criticism for requiring banks to find £27bn of more capital at a time when lending is weak, insisted that more capital was "crucial to building financial resilience".
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