The Bank of England has scrapped all Covid restrictions on shareholder payouts at the UK’s largest lenders, saying they remained “resilient” to economic shocks despite a growing list of new risks to the financial system.
Officials at Threadneedle Street said that banks were strong enough to weather the remainder of the Covid crisis, and continue lending to households and businesses throughout the recovery period.
Resilience among lenders, as well as an improved economic outlook, meant the Bank could finally lift its temporary cap on shareholder payouts by the UK’s largest banks, including Lloyds, Barclays and HSBC, that have been curbed for 16 months. “Extraordinary guardrails on shareholder distributions are no longer necessary,” the Bank said in its biannual financial stability report on Tuesday.
However, the Bank of England said new risks were emerging due to the unwinding of government support such as the furlough scheme, increased risk taking in global financial markets, and growing reliance on unregulated cloud service providers to run core banking services.
“This has been the first big test of the post-financial crisis reforms, notably to the resilience of banks, and so far the results have been encouraging,” said Andrew Bailey, the Bank’s governor. “In recent months the rapid rollout of the UK vaccination programme has led to an improvement in the UK economic outlook. But the risks of that recovery remain,” he warned.
Bailey said banks were encouraged to lend to households and businesses that would need continued support from the financial system as the government’s “exceptional support measures unwind over the coming months”.
The central bank said it was worried about “increased risk taking” in global financial markets, illustrated by increased demand for riskier assets such as high-yield corporate bonds, referring to debt issued by companies that are usually in some type of financial difficulty or highly indebted. This demand is partly due to the stronger economic outlook, as well as investors hunting for higher returns due to low interest rates.
But those investments are likely to be among the first to go sour in a future downturn. “This could increase potential losses in a future stress, and highly leveraged firms have also been shown to amplify downturns in the real economy,” the Bank warned.
The bank said the volatility of certain cryptoassets such as bitcoin and ether also illustrated risk-taking in global markets. While their influence on wider markets had so far been “limited”, the Bank warned that trend could change as more institutional investors, banks and payment providers actively invest and accept payments and deposits in cryptoassets.
The central bank also raised renewed concerns over the financial system’s increased reliance on a small number of unregulated cloud service providers for key parts of their operations.
The fact that a growing list of financial firms rely on just a handful of companies – such as Amazon, Google and Microsoft – to run their day-to-day services increases the risk that entire systems could be affected by cybersecurity risks, hacking and outages.
Bailey said the secrecy of suppliers could also put the banking system at risk. “That is why we do have a concern, and do have to look carefully, because that concentrated power on terms [and conditions] can manifest itself in the form of secrecy, opacity, [and] not providing customers with the sort of information you need to be able to monitor the risks in the service,” the governor said. “And we have seen some of that going on.”
Bailey added: “As they become more integral to the system, we have to get more assurance that they are meeting the levels of resilience that we need.”
The Bank said it was working with the Financial Conduct Authority and the Treasury to tackle the threat, but could only go so far without international cooperation given that most of those cloud service providers are headquartered overseas.
Bank shares rose to the top of the FTSE 100 in early trading after the financial stability report’s release, but most closed down at the end of the trading session.