BoE: UK Banking System Resilient Despite Trade Tensions

The UK banking system remains well positioned to support households and businesses even if economic conditions deteriorate beyond current expectations, according to the Bank of England's July 2025 Financial Stability Report.

The Financial Policy Committee maintained the UK countercyclical capital buffer rate at 2% following its assessment that domestic credit growth and debt vulnerabilities remain within historical norms. 

Major UK banks reported Common Equity Tier 1 capital ratios of 14.4% in the first quarter, while smaller institutions held 18.3%.

The decision comes as global trade tensions create uncertainty for UK corporates. US tariff announcements in April triggered sharp market volatility before a 90-day pause was announced on 9 April. 

The Bank of England's committee noted that while functioning remained orderly during the stress period, conditions could have deteriorated if volatility had persisted longer.

Mortgage market activity increases

Mortgage lending showed particular strength in the first quarter, with gross lending rising 38% from the previous quarter as buyers completed purchases before stamp duty changes took effect. The share of new lending at loan-to-income ratios of 4.5 or above reached 9.7% in the first quarter.

The Financial Policy Committee recommended that the Prudential Regulation Authority and Financial Conduct Authority allow individual lenders to increase their share of high loan-to-income lending while ensuring the aggregate flow remains consistent with the 15% limit. 

This follows analysis showing the current limit is not expected to constrain lending over the next decade.

Bank of England staff projections suggest the proportion of high LTI lending could reach around 11% by the end of 2025, driven partly by expected interest rate cuts and the FCA's recent clarification on mortgage stress testing.

The regulator confirmed lenders have reduced stress rates by around 110 basis points on average, testing new borrowers at rates between 6.5% and 7.5%.

Corporate sector shows aggregate resilience

UK corporate debt vulnerabilities remain contained in aggregate, with the net debt to earnings ratio falling to 122% in the fourth quarter of 2024.

This compares with peaks of 171% during Covid and 235% after the global financial crisis. Corporate insolvencies stood at around 50 per 10,000 firms in the twelve months to May, well below the long-term average of 100 per 10,000.

However, the Financial Stability Report highlighted specific risks for firms dependent on market-based finance. Around 10% of market-based corporate debt requires refinancing in the coming year, with highly leveraged borrowers particularly exposed to global shocks and tighter credit conditions.

Bank of England staff analysis indicates that firms in sectors vulnerable to trade disruption account for around 60% of UK employment but only 30% of corporate debt. These firms typically maintain lower leverage and stronger interest coverage ratios than those in less exposed sectors.

Non-bank leverage concerns persist

The committee expressed continued concern about leverage in non-bank financial institutions, particularly in gilt repo markets. Hedge fund net gilt repo borrowing reached £77 billion in early June, the highest level since data collection began in 2016.

This growth reflects increased cash-futures basis trading, where funds purchase gilts financed through repo and sell gilt futures contracts. The concentration remains pronounced, with a small number of hedge funds accounting for 90% of net gilt repo borrowing.

The Bank of England plans to engage with industry through a discussion paper exploring potential reforms to strengthen gilt repo market resilience, including expanded central clearing and minimum haircuts for non-centrally cleared transactions.

Banks face NBFI exposure growth

Major UK banks' exposures to non-bank financial institutions have increased from 17% of total assets in 2018 to 21% in 2024. Gross exposures to leveraged sectors including hedge funds, pension funds and insurers stood at around £510 billion as of January 2024, representing 225% of aggregate Common Equity Tier 1 capital.

While these exposures are generally well collateralised, the committee emphasised the importance of appropriate risk management given the complexities involved. The Prudential Regulation Authority and Financial Conduct Authority have previously outlined expectations for enhanced risk management in prime brokerage operations.

Private markets under scrutiny

The Financial Stability Report highlighted growing interconnections between private markets and the broader financial system. Private equity-backed corporates account for around 15% of total UK corporate debt and employ over two million people across diverse sectors.

The current higher interest rate environment and macroeconomic uncertainty have constrained funds' ability to exit investments through traditional routes such as initial public offerings. This has led to increased use of alternative strategies including continuation vehicles and net asset value financing.

The Bank of England intends to undertake structured engagement with private market participants to better understand how the sector might operate during a downturn and the potential implications for real economy financing.