George Osborne warns Bank of England over economic recovery plans

The chancellor told the Bank’s governor on Tuesday that Threadneedle Street’s new financial policy committee (FPC) should take account of the impact of its actions on “near-term economic recovery” when deciding on the regime under which banks operate, reports The Guardian.

In a letter to Sir Mervyn King, Osborne said there may be “short-term tradeoffs between the committee’s secondary objective of contributing towards economic growth and its primary objective of addressing sources of systemic risk, which may vary at different points in the economic and credit cycle”.

The letter highlights the Treasury’s concern that the Bank may set such tough capital and liquidity requirements for banks and other financial institutions that the flow of credit to business and households is impaired. After flatlining for two years, figures released last week showed that the UK economy grew by 0.3% in the first three months of 2013. Osborne is keen to ensure there is no relapse in the coming months.

“It is particularly important, at this stage of the cycle, that the (financial policy) committee takes into account, and gives due weight to, the impact of its actions of the near-term economic recovery,” the chancellor said.

Last month, the FPC sowed uncertainty among the main UK banks when it said they needed to raise an additional £25bn in capital to secure themselves against future problems.

The lack of clarity on the amount of capital banks need to hold is one of the issues impeding Lloyds Banking Group’s ability to decide if it can start paying dividends for the first time since the financial crisis began. Such dividends are regarded as crucial if the bank is to be sold to private investors. On Tuesday, Lloyds, of which 39% is owned by the government, reported a sharp rise in profits for the first quarter of 2013, to £2bn, despite its failure to sell 630 branches to the Co-operative Group last week.

George Culmer, the Lloyds finance director, said the bank was awaiting the outcome of discussions with the new Prudential Regulation Authority, spun out of the Financial Services Authority to regulate banks, over the size of any capital shortfall it may have. Culmer said he was unsure when Lloyds would know about its capital position.

Lloyds’s closely watched measure of capital – the core tier-one capital ratio – rose from 12% to 12.5% by the end of the first quarter. “Given our strongly capital generative core business and continued progress in increasing capital and reducing risk through non-core asset disposals, we continue to be confident in our capital position,” the bank said.

The FPC was set up at the Bank of England by the coalition government in response to what was seen as the regulatory failings that led to the crash of 2008. The committee has been operating on an interim basis since 2011 and only formally came into existence on 1 April.

Osborne used his letter to set out the remit for the FPC and to make recommendations about how it should operate.

“The damaging effects of the financial crisis revealed the need for macro-prudential regulation. Even if individual firms are believed to be sound, when their activities are considered in aggregate, risks to the whole system can emerge,” the chancellor said.

He added that under Labour’s tripartite system – in which the Treasury, the Bank and the Financial Services Authority all played a role in policing the City – no one authority had responsibility for addressing systemic risk.

Osborne instructed the Bank to agree and publish “those risks it intends to address as a priority, together with the underlying risk assessment and the time horizon over which it proposes to address them” by the time of its late 2013 financial stability report.