Britain's banks should build up their capital buffers even further as increased insurance against an exceptionally threatening environment still dominated by the euro zone debt crisis, the Bank of England said on Thursday.
Banks need to maintain lending to the real economy, but should restrain dividends and bonuses -- and possibly even issue new shares -- to build up these capital levels further, the Bank's interim Financial Policy Committee said.
It is sensible to raise the capital buffer further in order to improve resilience in light of the continuing threat to UK financial stability, the committee's chairman Bank Governor Mervyn King told a news conference.
He avoided setting specific capital ratio targets so as not to prompt banks to comply by selling off units or ending loans to businesses in order to push the ratio higher.
In the recent stress test of EU banks, UK lenders were not asked to raise any extra capital but the Bank remains cautious.
There is no simple answer to how much capital banks need to retain confidence, King said.
Bolstering buffers would help restore investor confidence and thereby cut the cost of rolling over the large sums of debt maturing the first half of 2012, he said.
Hector Sants, chief executive of the Financial Services Authority, told the news conference that banks will have to present their forward capital funding and bonus plans to make sure they are compatible with the Bank's objectives.
They have to preset those plans to the FSA before distributing any bonuses, Sants said.
The ring-fencing of retail arms of UK banks with dedicated capital cushions, a core recommendation of the recent Vickers Commission which set a 2019 deadline, should also be implemented as soon as possible, King said.
Angela Knight, chief executive of the British Bankers' Association, said, We agree with the Governor's analysis that the UK's banks are better capitalised than many of their continental peers, and further strengthening of their finances is continuing.
And in a sign that the FPC does not trust how banks report how indebted they are, it recommends that they be ordered to publish leverage ratios from the start of 2013, two years earlier than international Basel III rules require.
The interim FPC issued its first recommendations in June. Currently it only has an advisory role, but new laws are expected to make it Britain's top financial regulation body from the start of 2013.
Its role is to plug a pre-crisis gap by taking a broader view of risks to financial stability and recommending or ordering specific actions.
The FPC said the euro zone debt crisis remained the top threat to Britain's banking system and said lenders should look for ways to make themselves more resilient without shutting the credit taps to an already struggling economy.
Given the current exceptionally threatening environment, the Committee recommends that, if earnings are insufficient to build capital levels further, banks should limit distributions and give serious consideration to raising external capital in the coming months, the FPC said.
Current levels of capital were sufficient for and are better than many European peers, but higher levels would enable banks to maintain lending in the face of future shocks, King said.
Tier 1 capital ratios for UK banks, a key measure of stability, were well above 12 percent in the first half of 2011, among the highest in the world, and far above pre-crisis levels.
British banks are unlikely to react warmly to the FPC's calls. The chief executive of Royal Bank of Scotland -- which was rescued by taxpayers at the height of t he financial crisis -- said recently that onerous regulation meant investors believed UK banks were a dumb place to invest, and that it limited their ability to lend.
King, in testimony to British lawmakers on Monday, denied that tighter capital rules would constrain bank lending, though he did concede that there was more room for argument about liquidity rules.
The FPC said major UK banks are already very close to meeting their funding targets for 2011 and have 140 billion pounds of funding due to mature next year, most of it in the first half.
The FPC reinforced Britain's hard post-crisis regulatory stance by requiring banks to accelerate a key global reform, the publication of a leverage ratio, which measures a bank's debt-to-equity mix and ability to meet its obligations.
Under Basel III banks begin calculating their leverage ratio from 2013 but not publish it until 2015.
The FPC wants UK lenders to begin disclosing their ratio by the start of 2013, which will open them up to market pressure to restrain leverage, as intended by regulators.
The failure of Belgian bank Dexia in October - which had high capital levels -- signalled the importance of looking beyond capital buffers, which are complicated to calculate, to examine simpler indicators like leverage, the FPC said.
Opaque and overly complex regulatory risk-weight calculations and inconsistent and incomplete disclosure have increased uncertainty about bank resilience, it said.
Market intelligence suggest that investors are now questioning the reliability of ... the calculation of risk-weighted assets, it added.
(Reporting by Huw Jones and David Milliken; editing by Anna Willard)