Banks must retain more profits BoE warns

17th Dec 2010 08:27

UK banks should prepare for more financial turbulence ahead, especially in the eurozone, by retaining more profits, the Bank of England's latest financial stability report suggests. The Bank warns that the strong links between the UK and Europe would mean a knock on effect on British banks through losses on loans to households and companies, even though it sees the UK bank system as "largely decoupled" from the problems in Ireland, Portugal and Spain. "UK banks have claims of almost £300bn on France and Germany, whose banking systems are more heavily exposed to the most affected economies," the BoE says."It is in banks' collective interest to build resilience gradually through retention of earnings, which would be boosted if banks restrain distribution of profits to equity holders and staff," the report argues.The quarterly report highlighted a number of other potentially dangerous risks to the UK financial system, underlining the nervousness of central bankers generally over the situation in Europe.On bonds, the BoE cautioned that at the current low levels, "Bond yields internationally remain susceptible to further reversal". Fear over inflation or a fresh sovereign default panic could lead to contagion and heavy losses, it said. Too much money flowing into emerging and junk bond markets was another danger, as was the continuing ability of companies to meet their interest bills if profits faltered or interest rates rose. The Bank estimates that the big four UK banks could see their bad debts rise by £100bn if "write-off rates return to their pre-crisis average" and £150bn if losses on bad debts hit "levels seen in the early 1990s recession".The extra impairments will "be a further drain on banks' profits" at a time when UK lenders have to refinance £400bn to £500bn of wholesale funding in the next two years.