Sir Mervyn calls on UK banks to shore up capital

City Editor

Friday 2 December 2011

THE Bank of England has told banks to divert money for bonuses and dividends towards shoring up their capital cushions as it laid out in stark terms the "exceptionally threatening" economic situation caused by the eurozone sovereign debt crisis.

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tim sharp city editor

The call from Threadneedle Street came as Lloyds Banking Group, owner of Bank of Scotland, sought to bolster its capital base with an exchange offer for some of its securities.

Meanwhile, Glasgow-based Clydesdale Bank had its credit rating downgraded to BBB+ from A+ by Standard & Poor's after the agency reduced its assumption of how much parent company support a bank can expect.

Parent company National Australia Bank was downgraded from AA to AA-.Speaking on the day after the Bank of England joined other central banks in making it easier for banks to fund themselves, Governor Sir Mervyn King warned the eurozone sovereign debt crisis is leading to an erosion of confidence and falling lending."This spiral is characteristic of a systemic crisis," he said.The Bank's interim Financial Policy Committee (FPC) labelled the euro area crisis the "most significant and immediate threat to UK financial stability".Sir Mervyn said: "Here in the UK, we must try to bolster the resilience of our financial system better to withstand the storms that may come in our direction."This means limiting distributions such as dividends and bonuses.He also asked banks to consider raising more capital from investors. But he insisted they should continue lending to individuals and businesses.Banks will negotiate their plans for bonus and dividend payments with the Financial Services Authority. Its chief executive Hector Sants emphasised the limit of his authority: "The FSA doesn't have the power to specifically limit the bonuses here per se, but it has the power to ensure that banks have the right amount of capital."Many banks have already cut their bonus pools after dismal performance at their typically high-paying investment banks in the recent market turmoil. Edinburgh-based Royal Bank of Scotland put no bonus money aside in its third quarter.Threadneedle Street said it has considered contingency plans for a debt default by a eurozone country.Britain's banks hold little sovereign debt, but have "significant" exposures to the private sectors of Ireland, Spain and Italy, the Bank said, amounting to £160 billion or 80% of their core tier one capital.Sir Mervyn suggested the UK could face another credit crunch as bank funding dries up."You can see signs of a credit crunch already in the euro area. You could see how it could come through here if funding constraints remain as high as they are."Banks' ability to raise capital is in some doubt after RBS chief executive Stephen Hester said last week investors see UK banks as a "dumb" place to put money.RBS could tap an £8bn contingency reserve negotiated with the Government in return for its stake rising from 82% to 84%.Angela Knight, chief executive of the British Bankers' Association, said: "By strengthening their capital positions, the banks are taking action; it now falls to governments in the eurozone to take action." A spokeswoman for Lloyds said it is undertaking an exchange offer on some of its capital securities "in light of ongoing market volatility and regulatory uncertainty". It said this would improve the quality of its capital base.Meanwhile, Clydesdale chief executive David Thorburn said of its downgrade: "Our movement is largely attributable to the way parent company support is evaluated as part of the new methodology. "This is disappointing as the nature of NAB's support for Clydesdale remains unchanged. "It is important to recognise that we are a profitable, conservative bank with sound capital and funding."

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Sir Mervyn calls on UK banks to shore up capital

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