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UK banks' COVID-19 loan losses likely to be under £80B, says BoE

The Bank of England has revised downwards its estimate of future COVID-19-connected losses for U.K. banks, saying their capital buffers are robust enough to allow them to keep lending to the real economy.

Despite British lenders reporting an additional £18 billion of credit losses on outstanding loans in the first half of 2020, the BoE revised its future aggregate loss estimate to "somewhat less than £80 billion" on the back of more-benign GDP predictions from its monetary policy committee.

Banks have set aside billions for expected losses as a result of the pandemic, with some increasing provisions in the second quarter.

Lloyds Banking Group PLC swung to a first-half loss after setting aside a larger-than-expected £2.4 billion second-quarter loan loss provision — much higher than the first-quarter provision of £1.4 billion. It estimated that the impact of the pandemic lockdown was more significant than previously forecast.

HSBC Holdings PLC, for instance, increased its scope for full-year expected credit losses to between $8 billion and $13 billion, up from between $7 billion and $11 billion, which it had predicted in April.

Barclays PLC, too, booked a higher-than-expected loan loss provision of £1.6 billion in the second quarter, taking its total COVID-19 loan loss provisions to £3.7 billion.

NatWest Group Plc, formerly Royal Bank of Scotland, set aside an extra £2 billion to cover an expected rise in losses, after initially setting aside £802 million to deal with the crisis in May.

Standard Chartered Plc reported a six-fold year-over-year increase in impairment charges, with first half charges totaling $1.58 billion, up from $254 million.

Barclays, which has substantial unsecured borrowing through its credit card business, has the most set aside, with expected credit losses as a percentage of its loan book totaling 2.46%. Standard Chartered has set aside 2.30%, NatWest 1.72%, Lloyds 1.4%, and HSBC 1.33%.

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The BoE's latest Financial Stability Report, published Aug. 6, bases its predictions on the more optimistic projections published in the accompanying monetary policy committee report.

The MPC, which voted unanimously to maintain interest rates at 0.1%, took a more optimistic view of the U.K. economy than it had previously. It now expects a 9.5% decline in U.K. economic output in 2020 compared with a fall of 14% predicted in its May report.

In May, under the MPC's economic scenario, the BoE was expecting banks to see credit losses of just over £80 billion. The central bank notes that in the first half of 2020 banks have reported an additional £18 million of credit losses on outstanding loans.

But the financial policy committee said the latest, more benign, projection from the MPC regarding the effects of the pandemic on the economy would lessen banks' credit losses and that banks were well-equipped to cope.

"The FPC judges that the MPC's central projection would be consistent with credit losses of less than £80 billion and therefore continues to judge that banks' capital buffers are more than sufficient to absorb the losses that are likely to arise," it said.

"Taking into account the government's lending guarantee schemes, banks have the capacity to continue to provide credit to support the U.K. economy."

The BoE said that, since the start of the pandemic, businesses have raised more than £70 billion of net additional financing from banks ― primarily through government-backed loan guarantee schemes ― and through access to financial markets.

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Despite the relative optimism, the BoE acknowledges that the banking system cannot be resilient in all circumstances, noting that there are inevitably very severe economic outcomes that would challenge the banks' ability to lend.

But it emphasizes, as the BoE has from the start of the crisis, that continuing to lend is key to the most beneficial outcome for the economy and for banks.

"There are costs to banks taking defensive actions, such as cutting lending, in order to try to widen the range of possible outcomes to which they would be resilient. By restricting lending, those actions could make the central outlook materially worse," said the report.

The FPC focused on the capital buffers built up by banks to cope with unexpected stress and said the buffers are there to be used to allow banks to continue to lend. Indeed, it warns that reducing lending — a "defensive action" as it calls it — may be necessary but only if the economic situation is so dire that it jeopardizes banks' resilience and ability to absorb losses.

The FPC also carried out a "reverse stress test" to analyse how much worse the economic situation would have to be in order to deplete banks' regulatory capital buffers.

It estimated that to reduce capital ratios by around 5 percentage points, banks would need to incur credit impairments of around £120 billion. To reach that level of impairment there would have to be a very slow recovery from the 2020 first half economic shock and a double-dip recession later in the year. Indeed, the cumulative loss of economic output would have to be around twice as large as the MPC's central projection, with unemployment reaching about 15%, for instance.

The BoE estimates that the £120 billion of losses in the "reverse stress test" would deplete around 60% of the buffers of capital which sit above banks' minimum requirements. Banks could absorb a further £80 billion of losses arising from further shocks on top of that.