Sir Mervyn King said that the Financial Policy Committee believes that capital ratios are being understated and this uncertainty around capital adequacy is partly responsible for low investor confidence.
He said: “First expected future credit losses may be understated, second, costs arising from past failures of conduct may not be fully recognised and third the risk weights used by banks in calculating their capital ratios may be too optimistic.”
King said the committee recommends the FSA takes action and, where such action reveals capital buffers need to be strengthened, the FSA should ensure firms either raise capital or take steps to restructure their business and balance sheets.
He added: “Investors need confidence that banks have adequate buffers against stress in order to be willing to fund them at the low rates necessary to support a recovery.”
The Bank of England Governor said the world’s economic problems could not be solved by the UK alone but the situation must be tackled head on.
Without this approach, continued King, the UK would suffer a prolonged period of adjustment in which an inadequately capitalised banking system would hold back recovery in the wider economy.
He said: “At present a range of policy measures, including the Funding for Lending Scheme, have given banks a breathing space in which to reinforce their balance sheets. It is important that they take advantage of that breathing space.
“Our aim must be to get to a point where private investors again have confidence in banks and banks themselves have the confidence to lend. We believe that the recommendation we have made today, when implemented by the FSA, will soon get the UK banks back to a position where they can support our economic recovery.”
