LONDON (Reuters) - British banks may not have enough capital set aside as a defense against future financial market dangers due to their over-optimistic assessment of the risks facing them, the Bank of England said on Thursday.
The BoE's Financial Policy Committee, which from next year will take charge of British bank regulation, urged the current regulator to reassess whether banks' capital properly reflects the risk of loans going sour and future fines for misconduct.
Banks' true capital position was probably worse than relatively healthy official numbers imply, and that this is hurting investor confidence, the BoE said.
"Progress by banks in raising capital has slowed and investor confidence remains low," the BoE said in its half-yearly Financial Stability Report. "Market concerns are likely to reflect in part uncertainty about bank capital adequacy."
The FPC has repeatedly urged British banks to raise capital levels, and November's report marks a stepping up of these recommendations, despite a slight reduction in the risks facing the financial system due to an easing in euro zone tensions.
"UK banks' capital buffers, available to cushion losses and maintain the supply of credit following realization of a stress scenario, are not as great as headline regulatory capital ratios imply," it said.
Information from supervisors suggested some British banks would suffer bigger losses on loans than they had made provision for, it said.
Banks had also persistently underestimated the scale of fines they would face for past misconduct.
"In 2012, the number of identified conduct issues has grown and it seems likely banks could face additional sizeable costs," it said, adding that external analysts had suggested further costs of 4-10 billion pounds for mis-sold payment protection insurance and the LIBOR rate-rigging scandal.
The system of risk weighting that banks use to judge how likely they were to face losses was also "complex and opaque" and probably undermined investor confidence, the BoE added.
The BoE is also concerned that banks continue to lend to British businesses and households at a time when it blames a lack of bank credit as part of the reason for the country's very sluggish growth.
Inadequate capital buffers are not an excuse for reining back on lending, the central bank said.
"The Financial Services Authority should ensure that firms either raise capital or take steps to restructure their business and balance sheets in ways that do not hinder lending to the real economy," it said.
(Reporting by David Milliken and Alessandra Prentice)