UK Banking Sector Facing Challenges Amid Inflation and Interest Rate Hikes
Amidst rising inflation and ongoing interest rate hikes, the British banking sector is experiencing a surge in impairments, according to Bank of England Deputy Governor Sam Woods. In an effort to control runaway inflation, the central bank has raised its main interest rate from 0.1% in December 2021 to a 15-year high of 5.25% currently, and another hike to 5.5% is anticipated later this week.
While the economy has shown unexpected resilience, Woods, who is also the CEO of the Prudential Regulation Authority, stated that regulators are closely monitoring potential pressures within the banking sector. Woods conveyed to CNBC on Tuesday that the banking system was shielded from credit losses due to substantial fiscal and monetary support during the Covid pandemic. However, impairments in the banking sector are now increasing, although Woods assured that there is no cause for alarm.
The Prudential Regulation Authority estimates that slightly over 1% of mortgages are in arrears, noting that this figure was equally high in 2018 and reached 3.6% during the financial crisis. Woods clarified that the percentage is increasing, but it is still low, and close attention is being paid to the situation.
While the collapse of several small US lenders earlier this year caused instability in the global banking system, Woods emphasized that small banks in the UK are more than three times better capitalized than they were during the financial crisis. However, he expressed concern regarding shadow banks, which are financial intermediaries and lenders that are not subject to the same regulations as commercial banks. Woods highlighted events such as the 2021 collapse of small family office Archegos Capital, which resulted in over $10 billion in losses for the global banking system, as evidence that shadow banks can pose significant risks.
The non-bank financial sector gained attention in the UK in September 2022 when the Bank of England intervened to prevent the collapse of several pension funds following a crash in government bond prices and substantial changes in interest rates that exposed vulnerabilities in certain instruments. Woods stated that the Prudential Regulation Authority is closely monitoring these institutions and remains vigilant about the risks, including those arising from China’s economic challenges. China’s property market has been hit by declining consumer confidence, with real estate giants Evergrande and Country Garden on the verge of collapse due to mounting debt burdens. Woods added that the PRA is particularly interested in the impact on UK banks active in China.
While the UK banking sector navigates inflation and interest rate hikes, regulators are keeping a watchful eye on potential stresses and risks. The ongoing monitoring aims to ensure that the sector remains stable and resilient in the face of economic uncertainties both at home and abroad.