Worst of credit crisis may be over, BoE says total subprime losses appear significantly overstated
LONDON (MarketWatch) - In a signal that it believes the worst of the credit crunch may be over, the Bank of England said Thursday that the correction in credit markets has gone too far and that risk appetite and confidence were likely to gradually return to the financial system.
"Prices in some credit markets are likely to overstate the losses that will ultimately be felt by the financial system and the economy as a whole as they appear to include large discounts for illiquidity and uncertainty," the central bank said in a summary of its twice-yearly Financial Stability Report.
The bank said conditions would likely improve as market participants recognize that some assets look cheap relative to credit fundamentals.
"To reinforce those prospects of recovery, we need to restore confidence in the banking system," said John Gieve, the Bank of England's deputy governor for financial stability. "That is why we have launched the Special Liquidity Scheme and why I welcome the steps taken by some banks to strengthen their capital positions."
The liquidity program launched last week is designed to alleviate persistent tensions in the money markets stemming from banks' reluctance to lend to one another due to worries about solvency. Commercial banks are allowed to swap certain hard-to-move mortgage-backed securities with the central bank for U.K. treasury notes for up to a year. They can then use the government securities as collateral for loans from other banks.
While risk now appears overpriced, the central bank had warned in previous reports in 2006 and 2007 that financial markets had underpriced risk. "An adjustment was needed after the credit boom and will inevitably has costs, but it is proving even more prolonged and difficult than anticipated," the BOE said.
The BoE said loss estimates based on market values are now likely to overstate ultimate losses.
The central bank also warned that significant risks still remain, including the possibility that "current elevated risk premia persist and prompt further de-leveraging and tightening in credit conditions."
Such concerns highlight the need for more disclosure of banks' liquidity positions and to rebuild confidence in the resilience of banks, the report said, as well as for measures aimed at eliminating weaknesses in risk management, strengthening regulation and improving crisis handling.