BANKS WARNED THAT DEBT THREATENS RECOVERY / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

Banks warned that debt threatens recovery

By Norma Cohen and Jennifer Hughes

Published: June 25 2010 00:01

The UK’s economic recovery is at risk if the nation’s banks do not move swiftly to raise the £750bn-£800bn needed to refinance their borrowings due by the end of 2012, the Bank of England warns on Friday.

UK banks have greater refinancing needs over the next two years than lenders based in the US, Germany, France or Italy, according to the Bank’s Financial Stability Report, its twice-yearly statement on the nation’s financial system.

“There’s a risk banks alleviate their own funding pressures by further constraining credit conditions for customers,” the Bank said. “That would dent economic recovery and so raise credit risk for all banks.”

Moreover, the Bank said banks needed to cut their pay-outs in the form of bonuses and dividends still further. If the ratio of bonuses to profits fell to pre-crisis levels and banks held dividends steady they could add £10bn in fresh capital.

That would allow them to lend an extra £50bn to UK households and businesses.

The pressure on bank financing comes as the eurozone sovereign debt crisis has virtually closed the corporate bond markets for most of the past two months, cutting off a vital source of long-term funding at a critical time.

Britain’s banking system is particularly vulnerable because of its reliance on short-term borrowing to finance its long-term investments. UK banks will need to refinance £204bn next year, about twice this year’s needs and also twice their long-term borrowing average. This would require borrowing of about £25bn a month, more than twice the £12bn a month they have managed this year.

Borrowing costs for Greece and Portugal rose on Thursday to their highest levels since the eurozone launched its €750bn (£619bn) support package in May.

Mervyn King, the Bank governor, said the effects of a sovereign default were likely to be more severe than the bankruptcy of Lehman Brothers in September 2008. He said of talks among eurozone regulators about how a sovereign crisis would affect the banking sector.

“Dealing with a banking crisis was difficult enough, but at least there were public sector balance sheets on to which the problems could be moved. Once you move into the sphere of concerns about sovereign debt, there is no answer: there’s no backstop.”

The report noted that while UK banks have done a reasonably good job in raising capital relative to those on the Continent it would not be enough to shield them “against a conflagration of risk associated with a collapse of confidence in sovereign debt solvency around the world.”

Copyright The Financial Times Limited 2010.