The Bank of England is on alert for the reaction in financial markets to an anticipated rise in US interest rates for the first time since the financial crisis.
Threadneedle Street identified flows in and out of emerging markets as one area which was difficult to predict in the event of a rise by the US Federal Reserve at its meeting on 15 and 16 December. Janet Yellen, chair of the Fed, hinted last week that a rate rise was likely this month.
The Bank of England’s financial policy committee – set up to look for risks in the financial system – said there could be risks to stability from banks’ exposure to debt in emerging markets.
“Capital flows had been sensitive to diverging prospects for monetary policy around the world and there was a risk of further volatility in capital flows as that policy divergence progressed. Though the likelihood of a tightening in policy by US policymakers was widely expected, the market reaction to any decision by the FOMC to increase interest rates remained difficult to predict,” the record of the latest quarterly meeting of the FPC said.
“Given the size of UK banks’ exposures to emerging market economies, there were likely to be risks to UK financial stability associated with the rapid buildup in emerging market debt,” the FPC said. This is why it had incorporated a slowdown in emerging markets in to its annual stress tests of major lenders.
The results of those stress tests were announced last week and found that Standard Chartered and bailed-out Royal Bank of Scotland had the weakest financial positions of the seven lenders assessed. At the time, the Bank also flagged it was monitoring the buy-to-let mortgage market. The record of the meeting that led to last week’s announcement lists the main risks to financial stability as emerging market economies, financial market fragility, property markets, the UK ’s current account deficit and cybercrime.
It also provides more detail about last week’s announcement that banks may be required to hold a special capital cushion of up to £10bn to guard against any economic downturn through what are known as counter cyclical capital buffers. These buffers are currently set at 0% but could be raised at the next FPC meeting in March.
Some members of the FPC, which is chaired by Bank of England governor Mark Carney, had argued that the case for raising the buffer could be made soon.
“In the view of some members, it was too soon to consider an increase in capital buffers on UK exposures. Though overall credit growth had increased it remained below that of nominal GDP and below pre-crisis averages. Some members had judged the UK corporate sector to have been more risk averse recently and conditions in capital markets to have tightened, with some spreads more elevated than historical averages. In the view of other members, however, there could be a case for such an overall increase soon,” the record said.
On cybercrime, the Bank said and “attack was a serious and growing threat to the resilience of the UK financial system”.
“In the context of elevated geopolitical risks, the FPC emphasised the importance both of strengthening resilience to cyber attacks and of market participants having robust contingency planning arrangements in place that were regularly tested and updated to reflect current threats,” the Bank said.
