The world’s battered financial system is nursing estimated losses of $2.8 trillion but global intervention should bring about stability, the Bank of England said on Tuesday
Tentative signs have emerged that lending among banks is resuming, the Bank of England said in its twice-yearly Financial Stability Report. “Exceptional interventions by governments and central banks should help stabilize the banking system in the period ahead,” the Bank said. “While there are still risks in the wider financial system, the immediate response to the measures has been positive.”
In April, the Bank gave a fairly upbeat assessment of how severely the credit crunch would impact markets and the wider economy, but the central bank’s latest report is more cautious. “The instability of the global financial system in recent weeks has been the most severe in living memory,” said Bank Deputy Governor John Gieve. “And with a global economic downturn underway, the financial system remains under strain.” “We need a fundamental re-think of how to manage systemic risk internationally. We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy.”
Central banks and governments globally have made as much as £5 trillion ($8 trillion) available in support funding since April, but that level of help will have consequences, the Bank said. “Reducing reliance on the official sector as a source of funds is likely to be a significant constraint on banks’ activities over the medium term,” the Bank said. Banks will also need to lower their exposure to short-term wholesale funding and their leverage to improve the quality of their balance sheets, the central bank said. “Both are consistent with a period of tighter credit conditions for the real economy, compared to the period prior to the turmoil,” it said.
The roots of the credit crunch lie in the unwillingness of banks to lend to each other because of fear of what toxic, hard-to-value assets may be lurking behind each others’ doors. That has frozen up markets and cut vital credit lines to businesses, households and would-be homebuyers, helping to drive Britain towards its first recession since the early 1990s.
The Bank said “there are tentative signs that counterparties have become more willing to lend to banks on an unsecured basis” after Britain’s recapitalization package and similar moves by other countries. The government offered to inject £50 billion into banks and guarantee new short and medium term debt issuance at the start of October. The Bank also extended its Special Liquidity Scheme -- under which banks can swap hard-to-trade mortgage assets for government debt.
Interbank lending rates -- which spiked to unusually high levels in the height of the credit crunch -- have eased as a result of that rescue package, but fears of recession and further market turbulence are hampering a fuller recovery. “It seems unlikely that these spreads will return to pre-crisis levels, since these reflected an underappreciation of the risks on banks’ balance sheets,” the Bank said.
However, as it said earlier this year, the Bank of England believes current market prices are not reflecting the true value of losses from the credit crunch. “Mark-to-market losses have increased substantially since the April Report across the majority of instruments, roughly doubling for the United Kingdom and the United States, and rising by even more for the euro area,” the Bank said, estimating projected losses at $2.8 trillion. (Reuters)