LONDON (AFX) - The UK financial system remains "well placed to absorb unexpected losses" although the level of risk has increased since June, according to the Bank of England's latest Financial Stability Review. "While the risks facing the system have probably diminished since the immediate aftermath of the Sept 11 attacks, they have increased somewhat since the June review," it said.
UK banks face some increase in credit risk especially in parts of the corporate sector. There are also latent risks in rapid consumption and household borrowing growth. But the general system in the UK is relatively well positioned as major UK banks have remained highly profitable and well capitalised, it said.
Although corporate indebtedness is at a high level, income gearing remains low by historical standards. It will take a large decline in income to push gearing to levels seen in the early 1980s and 1990s. Further, a rise in gearing will not immediately imply greater risk of default if companies have adequate liquid assets, it said. In addition, major UK banks' earnings stream suggest that they should have scope to increase provisions as necessary should asset quality deteriorate. The review noted that risks in the commercial property sector had increased since June although well short of the fragility seen in the late 1980s.
In the meanwhile, the household sector has continued to run a financial deficit. Debt service problems may become more acute if any rise in unemployment is concentrated among financially weaker households, the review said. But the housing market is not seen a major source of risk for the country as a whole. House prices relative to consumer prices remain fairly close to their long-term trend except in London and the South East, it said.
Overall, however, both companies and households are now "somewhat more vulnerable" to unexpected falls in asset prices and incomes than six months ago. But both sectors should be able to service debts in the current interest rate environment, it added. Turning to the UK insurance sector, the review highlighted that pressures have risen from Sept 11 related claims and significant falls in equity and government bond yields which ultimately affect solvency margins. But these do not necessarily entail an increase in systemic risk, it said.
For life insurers, the challenge comes less from the Sept 11 attacks on the US than on developments in asset prices, it added. While the Monetary Policy Committee's November inflation report highlighted downside risks to sterling's exchange rate from a growing current account deficit, the UK's balance sheet position does not seem to pose a threat to financial stability, it added. On a broader scope, given the rise in debt across a range of sectors, global financial systems could face stresses not during the slowdown but in the early stages of recovery as interest rates begin to rise, the Review cautioned.
Commenting on the review, BoE deputy governor, David Clementi said the risks facing the financial system appear somewhat greater than at the time of the last review. "But the position is better than immediately after Sept 11, which temporarily created additional stresses and uncertainties," he said. "In the UK, there are few debt servicing problems in the current interest rate environment, although levels of borrowing in the corporate and household sectors imply some future vulnerability," he noted.
"Importantly, the banking system as a whole -- and this is true generally elsewhere, notably in the US -- is cushioned against increased international and domestic risks by strong capitalisation and profitability," Clementi added.