The Banker writes that UK banks are under pressure after the Bank of England (BoE) raised concerns about liquidity and capital adequacy risks linked to the growing market for synthetic risk transfers, as reported by the Financial Times.
In a letter sent to finance directors last week, the BoE warned of “prudential concerns” over how certain risk-transfer transactions are being financed, giving companies until June 11 to respond.
The BoE said it had observed “an imprudent approach” in how banks are categorizing financing provided through repurchase agreements to investors purchasing credit-linked notes issued by other banks.
Some lenders have been classifying financing for credit-linked notes within their trading books, allowing them to hold less capital than would be required if the exposures were recorded in the banking book.
The central bank warned that the practice is “resulting in a potential undercapitalization of the risks” and questioned the liquidity of the instruments involved.