Big banks may need to beef up their balance sheets warns Sir Mervyn King

Britain’s biggest banks have been warned that they may need to beef up their balance sheets to protect them against bills for customer compensation and loans turning bad.

The Bank of England said that the four largest banks – Barclays, HSBC, Lloyds and RBS – could have to increase their capital reserves by as much as 
£35 billion between them because “the current accounting regime may prevent banks from provisioning in a timely manner against losses that they expect to suffer”.

In its latest financial stability report, the Bank said lenders have “underestimated” expected losses on loans and the cost of redressing customers who were mis-sold payment protection insurance (PPI).

Sir Mervyn King, who will be replaced as the Bank’s governor by Mark Carney in July, said: “Some external analysts have suggested a range of £4bn to £10bn for further unrecognised PPI and Libor-related costs alone for major UK banks. It seems likely that banks could face further sizeable costs for other conduct redress and potential future legal challenges.”

The Bank’s financial policy committee urged the Financial Services Authority (FSA) to reassess whether lenders’ capital properly reflects their assets and the scale of future fines, adding: “The FSA should ensure that firms either raise capital or take steps to restructure their business and balance sheets in ways that do not hinder lending to the real economy.”

King said there was a “window of opportunity” for banks to build up capital reserves while using the £80bn Funding for Lending scheme (FLS), which offers cheap cash for lending on condition they pass it on to borrowers.

He said: “The choice we face is to tackle the situation head on, which will be difficult and in some quarters unpopular, or to suffer a prolonged period of adjustment in which an inadequately capitalised banking system holds back recovery in the wider economy.”

“Our aim must be to get to a point where private investors again have confidence in banks and banks themselves have the confidence to lend.”

King’s comments came as figures from the Bank showed that net lending to businesses edged into positive territory last month, although economists said the FLS is yet to have a dramatic impact on access to funding.

Net lending to non-financial companies rose by £100 million in October, having declined by £900m the previous month. For the third quarter as a whole, net lending fell by £1.1bn, following a £400m contraction in the previous quarter.

Michael Saunders, UK economist at Citi, said: “The latest monetary data suggest that the FLS continues to have only a very limited effect on credit availability, especially for small firms. The average interest rate on new business loans edged up to 2.92 per cent in October from 2.72 per cent in September and 2.66 per cent in August, when the FLS began.”

However, Santander said yesterday that the FLS had helped it increase its lending to Scottish SMEs by 43 per cent in the year to September, with a total of £115m in new funding delivered during that period.

Graham Silcock, its regional director for corporate banking, said: “There are some fantastic businesses in Scotland and we are proud to be providing not only funding but, more importantly, a committed long-term banking partnership with more of the nation’s strong and growing companies.”