The Financial Policy Committee (FPC) has recommended that the Financial Services Authority (FSA) consider lowering its microprudential liquidity guidance for banks while encouraging institutions to reduce “buffers” held above these guidance levels. The hope is that a release of liquidity “would be enough to make a big impact on real economy lending in the UK”, to quote the FPC’s Andrew Haldane.
There is little evidence, however, that bank lending is currently liquidity- as opposed to capital-constrained. The FPC has simultaneously recommended that banks further increase their capital buffers “to protect against the currently heightened risk of losses”. The Committee’s preference, of course, is that banks raise capital levels rather than boost ratios by cutting core assets but it is unclear how this is supposed to be achieved given weak profitability and lack of demand for bank equity and other capital instruments; the balance, in any case, is for individual institutions to decide, not the FSA. The net impact on lending of the contradictory liquidity and capital guidance, therefore, may be negative.
Banks, nonetheless, may take advantage of the revised liquidity policy, reducing holdings of low-yielding liquid assets in order to repay more expensive funding rather than increase loans. Banks are unable to lower the aggregate stock of reserves at the Bank of England, which is determined by QE; an individual institution can cut its own reserves by repaying borrowing but these will be transferred to another bank. A reduction in aggregate liquidity, therefore, would require sales of gilts and other high-quality marketable instruments.
Bank sales of gilts to the non-bank private sector have a negative impact on the broad money supply, since the buyers of the gilts pay for them by running down their bank deposits. Such sales, therefore, would offset the intended monetary stimulus from the recent further expansion of QE. The FPC’s liquidity initiative, in other words, as well as failing to stimulate lending, may serve to frustrate the efforts of its sister MPC.
