Significant risks remain with the continuing accumulation of debt by many borrowers and an aggressive search for yield, says the Bank of England.
The Bank has published its latest Financial Stability Review, which contains the Banks regular half-yearly review of risks to financial stability and measures taken to strengthen the financial infrastructure.
The Bank says that the continuing consumer debt has driven a rapid increase in the demand for a supply of highly leveraged financial products, particularly since June 2005. The review also highlights the fact that the relaxation of lending criteria in some markets and increased demand for illiquid instruments suggests that financial discipline may have weakened.
However, despite this warning the review also shows that the major UK banks remain well placed to absorb adverse shocks to their balance sheets. They are profitable, well capitalised and continue to take actions to guard against liquidity risk.
Sir Andrew Large, deputy governor for financial stability at the Bank of England, says: The UK financial system remains healthy and near-term risks appear limited. But there are issues of potential concern for the long run. These include the factors contributing to the backlog in confirmations and assignments, as well as widely reported relaxed lending criteria, and increase reliance by some market participants on potentially illiquid instruments and unpredictability of behaviour from new players.
These points raise questions about whether in some areas standards of procedure, risk appetite, and financial discipline have weakened. Experience from the past shows that such behaviour in stable times can create problems later. No doubt risk management has improved and risks are more widely dispersed.