The Lowdown Hub

Is there trouble brewing for cryptos, housing and debt in Europe? The Bank of England investigates.


The Bank of England has given a cautiously positive verdict to the banking system’s record on coping with the pandemic but also warned of more stresses that lie ahead.

Such a scenario could spring from the uneven way debt is building up among firms, or if the housing market overheats, according to the central bank’s Financial Stability Report.

Meanwhile, banks’ increasing reliance on cloud computing and the growing links between cryptocurrencies and mainstream finance could also pose problems, the latest report, which comes out twice a year and is written by the Bank’s Financial Policy Committee, said.


The committee was created in 2010 to bring together experts to monitor the safety of the financial system and is made up of twelve members from within the Bank and the Treasury as well as external appointments.

Its latest findings include a mix of issues the committee has chosen to highlight which could develop into problems and other policy measures.


Debt Companies’ debt levels have increased only “modestly” since the outbreak of the pandemic last March, but there has been a marked build-up in indebtedness among some small and medium-sized firms, particularly those exposed to the hardest-hit parts of the economy, such as hospitality.


A significant amount of that debt is in the form of low-cost Bounce Back loans, guaranteed by the government, but companies already with higher levels of borrowings “may be more vulnerable to increases in financing costs.


According to Sam Woods, chief executive officer of the Prudential Regulation Authority, the early indications on firms repaying Bounce Back loans is a “little bit more positive” than had been expected. The first of those loans taken out last May are coming due now. Borrowers can alternatively move on to “pay as you grow” deals to extend payments to ten years. That is getting “quite considerable take up”, while demand for new Recovery Loans, offered on more commercial terms, has been “quite low so far,” Woods said.


Household debt has increased “slightly” but remains much lower than levels before the financial crisis. The FPC noted the frenzied activity in the housing market in the first half of the year but said at the moment there had only been a “small increase” in riskier lending.


Capital Buffers Banks must continue to support businesses and individuals as they recover from the pandemic, was the loud and clear message, as it has been from the start of the crisis.

To help them do that, the countercyclical buffer, one of the capital buffers banks must have in good times, will remain at zero until at least December. To give time for banks to build up again, “any subsequent increase would not be expected to take effect until the end of 2022 at the earliest”, the FPC said.


The FPC swiftly moved the countercyclical buffer to zero from 1 percent in March last year to encourage banks to use their capital to lend to customers as the pandemic hit. The move freed up banks to lend £190 billion to businesses, the FPC said at the time.

While it was welcomed, banking bosses worried about how long the relaxation would last and whether investors would really accept banks eating into their capital bases to pump out loans.

Banks in fact built up their capital during the period, partly because they did not pay dividends last year, but also to boost their financial strength during the crisis. They were able to do that and lend to companies as they started with high capital levels and also because about £75 billion of loans were backed by the government, and so required less capital.


Crypto currencies Andrew Bailey, the Bank’s governor, reiterated a warning he has repeatedly made about the world of cryptocurrencies. “Any investors have to be very clear they could lose all their money and it has no intrinsic value”.

A warning, however, is not enough, as he added. “We clearly have to watch it very carefully and we do because it is a fast-changing landscape”.

The latest stability report noted the turbulence of prices, with Bitcoin having risen six-fold in the year to April before a 50 percent slump in May.


Despite the volatility, cryptocurrencies do not at the moment pose a risk to the whole financial system, the FPC found. That is because it is mainly retail investors who have piled into the assets, including Bitcoin and Ethereum, rather than big investors.


That is beginning to change. Institutional investors, banks, and big payments operators are moving into the area, which “could increase the interlinkages between crypto-assets and other systemic financial markets and institutions”.

Sir Jon Cunliffe, the Bank’s deputy governor responsible for financial stability, noted the risk was not systemic but that could change.


Meanwhile, the Financial Conduct Authority has taken various steps to warn consumers about the risks of investing in cryptocurrencies, including in June banning the exchange Binance from carrying out regulated activities in Britain. The regulator has ordered all cryptocurrency businesses in the UK to register with it and to meet its anti-money laundering requirements.


Brexit The UK’s departure from the European Union was notable by its absence from the main part of the Financial Stability Report, having been a prominent feature for several years. The last report in December, published on the eve of the transition arrangement coming to an end, Andrew Bailey sought to shore up confidence by saying the Bank had a “very substantive array of responses” to cope with potential market volatility. In reality, the switch from EU values to the UK’s independence was relatively smooth.


However, Brexit has not gone away, with several big issues yet to be resolved. One is whether firms inside the European Union will continue to be allowed to use London clearinghouses, which sit between deals and try to prevent defaults spreading through the market, after next year.


The EU granted a temporary extension for its firms to be able to use the likes of the London Stock Exchange’s LCH, one of the biggest clearing houses in the world, until the middle of 2022, in response to urgent calls by the firms which did not want to be forced to redirect their transactions inside the EU. It would be in the interests of the UK too to help maintain its place at the heart of global finance.


Sir Jon Cunliffe said alongside the latest report: “It is clearly a decision for the EU.The important thing for Britain is that whatever they decide, it is done in an ordered way”.

The UK is “very prepared for an open relationship. What we cannot do is for that decision to lead to disorder,” Cunliffe said.


The comments come after the chancellor used his Mansion House speech two weeks ago to acknowledge that equivalence - rules which would make access to EU markets easier - has not happened, and to layout plans, for the UK to set its own rules.


Open-ended funds The Bank of England has had funds where investors can buy and sell easily but the underlying assets are more illiquid in its sights for more than a year.

The pandemic increased the focus on the issue, as several open-ended property funds were suspended as managers struggled to cope with investors’ desire to withdraw their money at a time when selling large commercial buildings was almost impossible.

The incentive for investors to scramble for the exit in funds backed by property or bonds is a problem as it can escalate to fire sales and trigger runs on other funds, the FPC noted. That can lead to more forced sales, amplifying the problem.


The Bank of England and FCA are working on ways to clearly define the level of liquidity in funds and to explore “swing pricing”, where the cost of selling changes in times of stress.

The FPC said it “fully endorses” the work which has been done, but added that changes would need to be implemented internationally, as most large asset managers operate in several markets around the world.


As well as swing pricing, having longer redemption periods for property funds might make sense, and that could help the supply of finance to the economy in general, the FPC said.


Source: TLH. Intelligence and The Times, The Lowdown Hub 2021.