Bank of England reveals gloomy outlook

The Bank of England has painted a gloomy picture for bank write-downs on assets by banks, insurers and hedge funds, with potential losses blowing out to $US2.8 trillion.

In the bank’s latest bi-annual Financial Stability Report, it reports ‘mark to market losses on financial assets’ have almost doubled in the past six months since it produced its April report.

In the UK, potential financial institution losses have grown from _62.7 billion in April to _122.6 billion, while in the US, losses soared from $US738.8 billion to $US1,577.3 billion in October.

The bank notes that the demand for mortgage-backed securities globally has fallen dramatically since its April report, which is not good news for institutions.

“These developments partly reflect the deterioration in the global macroeconomic outlook and the likely increase in impairments on loans to households and corporates that are used to back securitised assets,” the report said.

“But current market valuations are also likely to reflect substantial discounts for uncertainty about eventual collateral performance and market illiquidity across structured product markets.”

However, the underpinning of the global banking system by various governments is lifting confidence in the sector.

“They (government measures) have increased banks’ capacity to withstand future losses and lowered the perceived risk of default significantly,” the report said.

A declining global economy is also putting more pressure on the banks, but the outlook is not all gloom, Bank of England deputy governor financial stability Sir John Gieve said.

“With a global economic downturn underway, the financial system remains under strain,” he said.

“But it is better placed as a result of the exceptional package of capital, guaranteed funding and liquidity support.

“That is helping to underpin the banking system both directly and by demonstrating the authorities’ determination to do whatever is needed to restore confidence.”

Those financial institutions that survive the current economic crisis will have to look at their risk models in the future to avoid further problems, Gieve said.

“We need a fundamental re-think of how to manage systemic risk internationally,” he said.

“There is a need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers it brings to the wider economy.

“That means not just increasing capital and liquidity requirements for individual institutions but relating them to the cyclical growth of risk in the system more broadly.”