Bank of England to relax capital rules despite warning of economic threats
The Bank of England set out proposals to relax UK banks’ capital rules even as it sounded the alarm on the growing risk of multiple threats hitting the UK economy.
In the latest meeting of the central bank’s Financial Policy Committee top officials said it would work with watchdogs on a package of “broad reforms” that aim to make the banks’ capital requirements “more proportionate and more effective”.
Britain’s top domestic-leaning banks including the likes of Nationwide, Natwest and Lloyds will be set to benefit from the streamlined rules that could unlock billions in capital previously tied up in buffers.
But the shake-up of regulatory system came as the Bank warned the “rapid progress” in AI capabilities this year had increased the “risks to financial stability from cyber and operational vulnerabilities”.
It added the vulnerabilities had transcended beyond just AI. The central bank said when excluding the top 30 AI-related stocks, the tracking of cyclically adjusted earnings yield compared to 10-year government bond yields was still the lowest since 2007.
The committee said this indicated the “stretch in valuations is more broad-based than AI-related optimism”.
The Bank warned there was “fragilities in the financing arrangements around AI investment, which could amplify the impact of a shock”.
“One example of this is when technology companies invest in Al companies which in turn purchase those technology companies’ products. This creates self-reinforcing capital loops.”
Andrew Bailey, the Bank’s governor, pushed back when questioned on the timing of capital changes amidst the growing risk. He described the changes as “targeted” and “appropriate”.
Bank warns ‘increased’ chance of multiple risks
The committee had previously warned the UK was at risk of “large and overlapping” shocks should vulnerabilities with AI crystallise simultaneously with the economy.
It said the likelihood of these risks occurring at the same time had “increased” since December, “potentially amplifying their combined impacts on financial stability”.
Still, the central bank said it was aiming to simplify the bank capital regulations through cutting away the countercyclical leverage buffer, which serves as an emergency financial cushion for lenders.
The plans also aim to align the calculations for systematically-important banks with international standards as well as redesign the core rules so that a large proportion of banks required financial reserves can be used for lending to families and businesses during financial stress.
Banks had been on a lobbying offensive over the last year for reforms to the capital regime.
A report earlier this year from the Association for Financial Markets in Europe (AFME) – which represents over 150 global banks, including the UK’s ‘big four’ – called for the removal of “excessive conservatism” in banking regulation.
Bailey said it would be “inappropriate” for the Bank to dictate whether the freed up capital is returned to shareholders.
“There is a decision to be taken in banks and with shareholders on how that capital is used… those decisions should be taken by institutions in a market economy”.
The decision to set lender’s capital requirements rests with the Financial Policy Committee, which reduced the minimum requirment to 13 per cent from 14 per cent at the end of 2025.
The rule dictates how much of a bank’s risk-weighted assets must be funds that can absorb unexpected losses without putting customers or the financial system at risk.