The Bank of England has today announced a comprehensive package of measures to help UK businesses and households during the economic disruption that is likely to be associated with COVID-19. The Bank stated that the economic shock could be “sharp and large, but should be temporary”. While the magnitude of the shock is uncertain, activity is likely to weaken materially in the UK over the coming months.
Monetary Policy Committee (MPC) reduces Bank Rate and launches new Term Funding Scheme with additional incentives for SMEs (TFSME).
At its special meeting ending on 10 March 2020, the MPC voted unanimously to reduce Bank Rate by 50 basis points to 0.25%. The MPC voted unanimously for the Bank of England to introduce a new Term Funding scheme with additional incentives for Small and Medium-sized Enterprises (TFSME), financed by the issuance of central bank reserves. The MPC voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
The Bank stated that it is likely to be difficult for some banks and building societies to reduce deposit rates much further given interest rates are low and this may in turn limit their ability to cut their lending rates. In order to mitigate these pressures and maximise the effectiveness of monetary policy, the TFSME will, over the next 12 months, offer four-year funding of at least 5% of participants’ stock of real economy lending at interest rates at, or very close to, Bank Rate. Additional funding will be available for banks that increase lending, especially to SMEs. Experience from the Term Funding Scheme launched in 2016 suggests that the TFSME could provide in excess of £100 billion in term funding.
The Bank stated that TFSME will:
• Help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that businesses and households benefit from the MPC’s actions.
• Provide participants with a cost-effective source of funding to support additional lending to the real economy, providing insurance against adverse conditions in bank funding markets.
• Incentivise banks to provide credit to businesses and households to bridge through a period of economic disruption.
• Provide additional incentives for banks to support lending to SMEs that typically bear the brunt of contractions in the supply of credit during periods of heightened risk aversion and economic downturns.
Additional information about the TFSME can be found here.
Financial Policy Committee (FPC) releases the UK Countercyclical Capital Buffer
The FPC has reduced the UK countercyclical capital buffer rate to 0% of banks’ exposures to UK borrowers with immediate effect, to support banks’ ability to supply credit during this period of disruption. The rate had been 1% and had been due to reach 2% by December 2020. The FPC expects to maintain the 0% rate for at least 12 months, so that any subsequent increase would not take effect until March 2022 at the earliest.
The economic disruption from COVID-19 should have less of an impact on the core banking system than recent stress tests run by the Bank have shown the system can withstand. Those stress tests demonstrated that banks would be able to continue to lend to businesses and households even while absorbing the effects of substantial, prolonged economic downturns in both the UK and the global economies, as well as falls in asset prices much larger than experienced in recent weeks.
The release of the countercyclical capital buffer will support up to £190 billion of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019. Together with the TFSME, this means that banks should not face obstacles to supplying credit to the UK economy and to meeting the needs of businesses and households through temporary disruption.
Prudential Regulation Committee (PRC) issues Supervisory Guidance
The release of the countercyclical capital buffer reinforces the expectations of the FPC and the PRC that all elements of banks’ capital and liquidity buffers can be drawn down as necessary to support the economy through this temporary shock.
The Prudential Regulation Authority (PRA) has set out its supervisory expectation that banks should not increase dividends or other distributions, such as bonuses, in response to the policy actions announced today. Major UK banks are well able to withstand severe market disruption as they hold £1 trillion of high-quality liquid assets, enabling them to meet their maturing obligations for many months.
In response to the material fall in government bond yields in recent weeks, the PRC has invited requests from insurance companies to use the flexibility in Solvency II regulations to recalculate the transitional measures that smooth the impact of market movements.