Bank of England Says Global Downturn Poses U.K. Stability Risk

By Jennifer Ryan and Brian Swint

Oct. 28 (Bloomberg) -- The Bank of England said the world economic downturn and turbulence in emerging markets pose heightened risks to Britain's financial stability.

The central bank said that the global financial system faces the ``most severe'' instability in living memory. Policy makers stopped publishing a summary of potential threats in a semi-annual assessment released today in London, noting some risks it predicted before have crystallized.

``With a global economic downturn under way, the financial system remains under strain,'' John Gieve, deputy director for financial stability at the central bank, said in a statement. ``But it is better placed as a result of the exceptional package of capital, guaranteed funding and liquidity support.''

The assessment is more pessimistic than the one Bank of England policy makers released in May, which said investors' views about asset prices and risk may have been overly bleak.

Prime Minister Gordon Brown suggested yesterday he may scrap decade-old fiscal rules as the crisis forces his government to raise spending and prop up the banking industry. The pound had the biggest intraday decline in at least 37 years on Oct. 24 after data showed that the economy contracted the most since 1990 in the third quarter.

The bank said in May that risk prices had become ``too high relative to fundamentals.'' Today's publication didn't include a table of risks posed by events such as a major financial institution falling into distress and wider credit-risk premia.

Banks are under continuing strains after losses on asset- backed debt, corporate bonds and other securities in the U.K., U.S. and Europe more than doubled since April to about $2.8 trillion, the bank said.

Credit Lines

They also face risk from non-financial companies borrowing more on existing credit lines as growth slows, the bank said. It predicted that widespread use of them may boost lenders' exposure to struggling industries by as much as 160 billion pounds ($248 billion).

The International Monetary Fund predicts the world's advanced economies will next year grow at the slowest pace since 1982. Investors stung by losses from developed nations have sold riskier emerging market assets, jeopardizing the position of those nations. The IMF has agreed to a emergency loans for Ukraine and Hungary. Belarus and Pakistan are seeking help.

Brown pledged yesterday to increase spending and borrowing to ease the economic slump, suggesting Chancellor of the Exchequer Alistair Darling may scrap a goal to limit debt to 40 percent of gross domestic product. The government plans to spend 50 billion pounds buying stakes in cash-strapped banks.

For a more permanent solution, regulators should consider forcing banks to increase their capital requirements and loss provisions when their loan books are growing, today's report said. Varying capital requirements and dynamic provisioning would help keep the financial system stable in a downturn.

``We need a fundamental re-think of how to manage systemic risk internationally,'' Gieve said. ``We need to establish stronger restraints on the build-up of risks in the financial system over the cycle with the dangers they bring to the wider economy.''

To contact the reporters on this story: Jennifer Ryan in London at Jryan13@bloomberg.netBrian Swint in London at bswint@bloomberg.net.