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Bank governor Mark Carney eases rules for banks to meet Brexit challenge

Bank governor Mark Carney said the measures were a "major change"

The Bank of England took steps on Tuesday to ensure British banks keep lending and insurers do not dump corporate bonds in the "challenging" period that is likely to follow the country's vote to leave the European Union.

The central bank said risks it had identified before the referendum were starting to materialize, including lower demand for commercial property. Late on Monday, insurer Standard Life (SL.L) said it had halted withdrawals from its main British real estate fund.

The central bank also said it was closely monitoring investors' willingness to fund Britain's large current account deficit after the shock outcome of the vote, as well as high levels of household debt and the subdued global economy.

"There is evidence that some risks have begun to crystallize. The current outlook for UK financial stability is challenging," the BoE said after its Financial Policy Committee held two meetings after the June 23 referendum.

Sterling dropped more than 10 percent against the dollar and banks' share prices fell by a fifth after Britons unexpectedly voted on June 24 to leave the EU, prompting Prime Minister David Cameron to say he would step down.

Sterling touched a new, 31-year low against the U.S. dollar earlier on Thursday, hurt by Standard Life's suspension of trading in its British real estate fund.

Twenty and 30-year British government bond yields briefly touched new record lows of 1.473 percent and 1.606 percent after the BoE's announcement.

Cameron's ruling Conservative Party is now selecting a new leader, who will decide how soon and on what terms Britain will leave the EU after more than 40 years of membership.

With uncertainty about the future of George Osborne as finance minister, more responsibility has fallen on Bank of England Governor Mark Carney and his fellow BoE policymakers to steer Britain through its worst political crisis in decades.

Fresh signs of weakness in Britain's economy appeared on Tuesday.


› Bank of England won't let banks raise dividends due to capital easing: Carney
Confidence among businesses fell sharply in the data after the vote to leave the EU, a survey showed, and retailer John Lewis said its sales grew more slowly last week.

Britain's dominant services industry also grew at its slowest pace in three years in June, according to a survey conducted mostly before the referendum.


As part of its announcement on Tuesday, the BoE's Financial Policy Committee said it would reverse a decision it took in March to increase the amount of capital banks must hold against cyclical upturns in the credit cycle.

Holding the so-called counter-cyclical capital buffer (CCB) at zero until at least June 2017 would reduce banks' capital requirements by 5.7 billion pounds, potentially freeing up an extra 150 billion pounds for lending, the BoE said.

Finance minister Osborne told parliament he planned to meet the chief executives of Britain's biggest banks on Tuesday to discuss future action.

"The FPC stands ready to take actions that will ensure that capital and liquidity buffers can be drawn on as needed, to support the supply of credit and in support of market functioning," the BoE said.

It has intensively monitored markets since June 24, ramping up checks it made during the 2008 financial crisis.

After the initial market turmoil following the Brexit vote, British lenders showed only contained demand for central funds at a six-month liquidity auction last week, including at an auction held on Tuesday.

The BoE has said the normal monthly auctions would continue weekly as a precaution.

"These measures are really about Carney aligning the Bank of England's guns in case the UK economy enters a downturn," Aberdeen Asset Management Investment Manager James Athey said.

"Markets are going to be reassured by his proactivity. He's not waiting for anything bad to happen but rather acting in case it does."

Carney has said he believes the central bank would need to cut rates and possibly provide other stimulus over the summer to cushion the shock of voting to leave the EU.

The BoE on Tuesday gave insurers more time to adjust to new EU capital rules to avoid pressuring them to dump corporate bonds and avoid high capital charges as interest rates plunge.

Before the referendum, consumer borrowing was rising at its fastest rate in a decade while mortgage lending had eased slightly as higher taxes on landlords and second-home buyers took effect in April.

The BoE said it would keep a close eye on the buy-to-let mortgage sector, in case landlords sell up as property prices fall, as well as on the rising numbers of vulnerable indebted households.

It expressed concern about a fall in investor demand for British assets - which could make it harder for the country to finance its large current account deficit - as well as trouble in commercial real estate making it harder for businesses to use their property as collateral to obtain loans.

LONDON Real Estate Appeal

Sterling's steep fall post-Brexit could offset some of the effects from tax increases introduced in April, which made buying properties especially in central London, an area favoured by foreign buyers, more expensive. There were signs that this was already happening in the top-end of the residential market.

"We have made a number of sales," David Adams, a managing director at luxury real estate agent John Taylor said, anticipating more Middle Eastern interest at the end of Ramadan in properties worth between 2 and 6 million pounds.

He said they had also had some interest and an offer on apartment blocks from 23 million to 45 million pounds.

"We have an immediate uplift (in sales to the) Middle East, United States and Asia, but we have a decrease in English domestic buyers, because of political instability."

Ed Mead, executive director at estate agent Douglas and Gordon had also seen an increase in foreign interest, but said the broader prime central London market would continue to struggle with the kind of uncertainty seen before the vote.

"We had four separate buyers who put in offers (the day after the vote), which were quite cheeky but clearly based on the fact they were getting an extraordinarily abnormal deal," he said.

The offers, which were in the over one million pound range and came from U.S. and European investors, had "clearly been brought about because of the fall in sterling".

"The potential fallout from getting it wrong politically is strong and people simply want ongoing stability, both political and (in the) currency.


There were also signs that the fallout from Brexit was benefiting professional investors such as private funds at the expense of homebuyers, who may struggle along with the economy.

Before the referendum, officials said the economy could tip into recession and house prices could fall 10 to 18 percent if Britain voted to leave the European Union. Economists polled by Reuters before the vote said they expected house prices to be flat next year and then pick up again if Britain chose to leave.

David Galman, sales director at Galliard Homes, said professional investors had already contacted him offering to buy any units end-users may seek to sell in the Skyline residential development it launched in June just outside London.

Galliard Homes, London's second largest house-builder, had offered buyers get out clauses for the 89 off-plan units ranging from 200,000 to 250,000 pounds in their development in Slough, west of London. The buyers had the option to withdraw their offers if they were unhappy with the outcome of the EU vote.

Galman said just one client, "an owner occupier" had thus far invoked a Brexit clause but that flat had already been sold at the same price to a professional investor.

House price risk

The FPC also has concerns over "the high level of UK household indebtedness [and] the vulnerability to higher unemployment and borrowing costs" for some households.
House prices could also come under pressure, particularly if buy-to-let investors abandon the market, it said.

The FPC said that banks were now well capitalised and that the Bank of England would postpone demands for £5.7bn of extra financing to be held on the banks' balance sheets - known as the "countercyclical capital buffer".

The Bank would reduce the level of the buffer - set to be introduced next year - from the planned 0.5% of a banks' lending "exposure" to 0%.

The 0% rate would be maintained until at least June next year, the FPC said.
It said it made the move because "a number of economic and financial risks are materialising".

'Fragility' concern

Given that banks leverage their lending, the FPC said the buffer reduction would allow banks to increase credit supply to households and businesses by £150bn.
It is hoped that will mitigate any effect of an economic slowdown which many predict.
The FPC also said it was acting to reduce any "fragility" in the financial markets and was ready to move further if necessary.
Its report said that maintaining foreign investment, necessary to support the UK's historically high current account deficit, could become harder following the decision to leave the European Union because of a "prolonged period of uncertainty".

"These measures are really about Carney aligning the Bank of England's guns in case the UK economy enters a downturn. Markets are going to be reassured by his pro-activity," said James Athey from Aberdeen Asset Management Investment.

"He's not waiting for anything bad to happen but rather acting in case it does. It also means that both halves of the BoE: the monetary policy and financial policy are pulling in the same direction."

The Bank of England warned that commercial property is a key risk to the economy following the Brexit vote.
The Bank avoids using the word "crash".
But the concern, put simply, is that the market for commercial property - from warehouses to office space to retail parks - is in deep trouble.

Foreign investors purchasing commercial property have made up 45% of all commercial property bought and sold since 2009.

Even before the Brexit vote, that inflow of money to the UK had slowed down, falling by 50% in the first quarter of 2016.
'Marked adjustment'

The Financial Policy Committee warns that: "Valuations in some segments of the market, notably the prime London market, had become stretched."

To translate that from Bank of England-speak: prices have been too high.
The Bank's Financial Stability Report points out that share prices of real estate investment trusts have fallen sharply and warned of the risk of "future marked adjustment in commercial real estate prices".

To translate that from Bank of England speak: there is a risk that commercial property prices may plummet.

Much of the most valuable prime London commercial property is, of course, in the City, where some foreign investors such as banks and investment managers have helped to fund an intense and ongoing bout of construction, symbolised by iconic buildings with nicknames such as the Gherkin, the Cheese-grater or the Walkie Talkie.
Current account deficit

The foreign money coming in to the UK is crucial in another respect.

Ever since the 1980s, the UK has earned far less selling goods and services abroad than it has spent on imports, creating a "current account deficit". Crudely, there's more money going out than coming in.

For years, we have made up for that by attracting money to the UK in two ways. First, foreign investors have been willing to buy shares in UK companies and lend money to our government.

And second, foreign companies have been ready to invest directly by, for example, constructing new buildings in the City of London, or investing in businesses like Jaguar Land Rover to turn them into a success.

The FPC report says all inflows of foreign investment in British companies slowed down in the run-up to the referendum.
Investors now believe they are taking a bigger risk than before investing in UK companies, which is reflected in share prices and the biggest two-day fall in the value of sterling in more than 40 years.

There comforting words in the report. The banks, for example, have been stress tested against a scenario where commercial property falls by 30% and residential by 35%, with a severe recession.
The banks have £600bn in "high-quality liquid assets" - such as shares in top companies, government bonds and cash. They could withstand losses twice as large as those endured in the crisis of 2008 without running out of money.

Comforted by that, the Bank of England has judged that the banks no longer need to build up £150bn as a "counter-cyclical capital buffer". The counter-cyclical buffer is simply cash which is set aside in good times so that it can be made available when the down-swing comes.
The fact that precisely that is now happening - £150bn is being made available - suggests that the Bank fears the down-swing is now here.

Sections of the Financial Stability Report
Part A: Main risks to financial stability ​ ​
   ​Financial market fragility
   ​UK current account
   ​UK commerical real estate
   ​UK household indebtedness
   ​Global environment
​Part B: Resilience of the UK financial system

Additional material

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