Reflections on Financial Stability in 2020 and 2021

The Bank of England's Agent for Greater London, Joe Ganley, reflects on the Bank's recently published Financial Stability Report. This article considers the economy in 2020 and looks forward to how 2021 will be effected by the events of the past year.

January 2020

The Bank of England’s Financial Policy Committee (FPC) works to ensure that the financial system is ready for any risks it might face, so that it can continue to serve households and businesses in bad times as well as good.

Last year, more than ever, those households and businesses have needed support from the financial system to weather the disruption brought by Covid. Underpinned by guarantees from government, businesses have borrowed £80bn so far, four times the amount they had raised by this time in 2019. The hardest hit have had their incomes protected by the extension of the furlough scheme, while households have been supported with payment holidays on mortgages, loans and credit agreements.

Thanks to the resilience built into the system after the financial crisis over a decade ago, UK banks have been able to provide this support despite the challenges brought by the pandemic. The reforms to our banking sector since the financial crisis, largely through increasing the amount of financial resources they have to hold, has meant that they have been able to continue to lend despite losses as a result of Covid.

Banks now hold three times more capital, known as their loss absorbing ability, than they did before the financial crisis. To date they have provisioned for £20bn of credit losses as a result of the economic effects of Covid to date. However, their capital buffers mean that they could absorb losses of almost ten times that amount.

We have also reached the end of the transition period with the EU. Since the referendum over four years ago, firms and authorities in the financial sector have made extensive preparations and as a result most risks to financial stability have been mitigated.

However, financial stability is not the same as market stability. As we move into new arrangements with the EU, some market volatility, particularly in foreign exchange and equity prices, and disruption to financial services could arise. Whatever our future relationship with the EU, the FPC remains committed to maintaining high regulatory standards in the UK.

One of the economic effects of Covid is that the mortgage market has tightened and there has been less availability of high loan‐to‐value (LTV) mortgages. History shows us that financial crises can often be associated with the property market which is why we guard against the biggest risks here. One of those is the FPC’s mortgage market recommendations which limits the proportion of new high loan‐to‐income (LTI) mortgages. Its aim is to protect households against shocks to their income and jobs and future increases in interest rates. But those risks change over time, especially whether the measures are calibrated correctly, which is why we will be reviewing our recommendations again next year.

Finally, Covid has accelerated the trend toward digital payments. The FPC have been considering the potential effects on the financial system were stablecoins – the most commonly heard example being Libra (recently renamed as Diem) ‐ to be adopted widely. Stablecoins are digital tokens that claim to maintain a stable value in relation to existing national currencies. As part of our work on this, we will also consider the issues that may arise from the introduction of a central bank digital currency, or in other words an electronic form of Bank of England issued money that could be used by businesses or households.

Covid has presented unprecedented challenges for the UK and global economy. To end on a positive, the financial system has proved resilient to those challenges and the work that the FPC and the Bank of England does will mean that this continues to be the case into the future.