–FPC Seen Pushing Larger Role For Macroprudential Policy Tools
–BOE Quandary As It Pushes Banks To Lend More And Boost Capital
–Banks Face “Mad Grab” For Capital Due Stress Tests, EU Capital Laws

LONDON (MNI) – The Greek debt crisis, and the increasingly real
threat of contagion in the eurozone bloc, looks set to dominate the
Bank of England’s first Financial Policy Committee press conference this
Friday but just as important in the minds of the members of the FPC will
be how to get UK credit to SMEs and home buyers flowing again.

In his Mansion House speech last Wednesday BOE Governor Mervyn King
conceded that there was a real prospect of contagion from the peripheral
EMU debt crisis.

“A year ago, we met in the wake of a major sovereign debt crisis in
Greece with market nervousness about how far that might spread. Since
then, this crisis of external indebtedness has consumed Ireland and now
Portugal, as well as Greece. Current account imbalances in the euro area
remain large, should concern us all, and will certainly affect us all”.

In his role as vice chairman of the European Systemic Risk Board,
King told a press conference Wednesday that it was “pretty obvious” what
the major risk to European financial stability is – a clear reference to
Greece.

In comments Tuesday, UK Treasury Minister Mark Hoban played down
the exposure of UK banks to Greece, saying it was no more than $4
billion.

The French banks’ exposure “is about four times that amount and the
German’s exposure about five times that amount,” Hoban said.

But a research note from one economic consultancy suggests that
with the City of London busy in the CDS market the actual degree of
exposure could dwarf direct lending by UK financial institutions to the
country.

Fathom Consulting noted how UK financial institutions could have,
for example, sold CDS to French banks cover direct loan losses to the
Greek and the French banks could cash in their CDS insurance if they
are hit hard by a Greek default.

The crisis is also posing some potentially life-threatening
questions for the CDS sector, as euro zone governments and the European
Central Bank seek to circumvent a Greek default at all costs – so
undermining the point of insuring against default.

The architecture and modalities of the new FPC have been set up to
echo the Monetary Policy Committee’s operations.

The FPC will meet only four times a year, compared to 12 for the
MPC, but it will hold an on-the-record press conference on the biannual
Financial Stability Review, with the FSR playing the part of the MPC’s
quarterly Inflation Report.

Minutes of the FPC meetings will be published, in the same way the
MPC minutes are, and FPC members will have to observe a strict purdah
period before and after the meetings of the committee.

With the domestic UK economy flatlining despite Bank Rate at 0.5%
and an outstanding stock of stg200bn of asset purchases, the BOE is
obviously looking for other policy tools to give the stuttering economic
recovery a bit of a fillip.

Getting bank lending moving again is key to sustaining the recovery
and to the normalisation of policy. As King has explained – the
dysfunctional bank lending market is a big reason for holding off on
Bank Rate hikes.

“Spreads between Bank Rate and the interest rates charged to many
borrowers remain at unprecedentedly high levels, if indeed borrowers are
able to access credit at all. When conditions in the banking sector
return to something closer to normal, those spreads will contract and
the rate at which that takes place will have an important influence on
the speed at which Bank Rate will rise,” King said.

The June minutes of the MPC showed some members of the no rate
change camp contemplating the possibility of further QE should deflation
become a plausible prospect, but with CPI looking set to easily breach
5% in coming months it will be very difficult for the MPC to credibly
plead that deflation is a real risk.

Getting credit moving and attempting to get the recovery back on
track may well fall to other policy tools, with macro-prudential policy
providing a vital weapon. Deciding the form and the operation of these
tools will be something which the interim FPC will be working on over
the next year.

As the BOE states:

“The interim FPC will undertake, as far as possible, the
forthcoming statutory FPC’s macro-prudential role. An important initial
task will be to carry out preparatory work and analysis into potential
macro-prudential tools.”

The Government’s consultation document states that the interim FPC
“… will play a key role in the development of the permanent body’s
toolkit by sharing its analysis and advice on macro-prudential
instruments with the Treasury, to help inform the Government’s proposals
for the FPC’s final macro-prudential toolkit”.

In the meantime, exhortation and a clear focus on key areas of the
financial system which may pose threats to financial stability issues
will have to fill those policy gaps.

During his Mansion House speech, King noted that during the run-up
to the financial crisis the BOE FPC would have been able to tighten
macroprudential policy to make banks hold more capital against more
riskier lending activities. That would not be the case now, he said.

“The present problem is the reverse – lending is weak. We shall
next week make recommendations in areas where, in our judgement, risks
to the resilience of the system are increasing,” King said.

That said, the financial crisis and the ensuing regulatory backlash
has left UK banks desperately seeking to rebuild their capital bases.
The BOE leadership tends to square this dilemma by urging banks to
exploit all opportunities to bolster their capital ratios and to target
dividend and bonus cutting in their effort to raise capital.

All of which is easier said than done, the banks will doubtless
say, as they struggle to keep their shareholders happy and hang on to
their most talented staff.

Upcoming EU bank stress tests (expected mid-July) as well as EU
legislation calling for increased capital requirements and the debt
crisis will also pile the pressure on banks to grab as much capital as
they can lay their hands on over the next few months.

Coming at the same time as the Greece crisis and as the threat of
contagion to larger euro zone economies becomes ever more real, another
perfect financial storm looms on the horizon.

The BOE will release its Financial Stability Report at a press
conference at 0930GMT Friday.

–London Bureau; Tel: +442078627492; email: dthomas@marketnews.com

[TOPICS: M$B$$$,M$$BE$]