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LONDON (Reuters) - UK banks may no longer be allowed to trim their capital reserves if doing so fails to increase lending in the struggling economy or undermines financial stability, Britain's top banking regulator said on Wednesday.
Andrew Bailey, head of prudential regulation at the Financial Services Authority, said regulators are trying to explain more clearly what banks can do in terms of easing back on capital holdings if they lend more, and how much of what sort of capital a bank needs to remain resilient.
The Bank of England's risk watchdog, the Financial Policy Committee (FPC), said in September banks do not have to hold as much capital -- but at the same time suggested lenders should build up reserves by keeping profits and cutting bonuses.
Banking industry officials complain privately about mixed messages and point out that markets would in any case get nervous about lenders who report falling capital reserves.
Bailey said there was a need to fill in "what for me is the big gap at present, namely how we explain and calibrate the resilience objective in terms of capital".
The FPC will focus on this at its next meeting and it was too soon to assess the impact of these capital changes on the resilience of the financial system and on credit creation.
"We will monitor the results of these actions very carefully, and we will be prepared to amend our judgments in the light of experience," Bailey told the annual conference of the British Bankers' Association.
The FPC has twin objectives of maintaining financial stability and supporting the economic policy of the government which wants more credit flowing into the recession-hit economy.
It is one of a new breed of watchdog practicing that seeks to cool asset bubbles before they destabilize the economy or cut some slack for banks in tough economic conditions.
The policy is in its infancy compared with a central bank's other main role in setting interest rates and FPC members have been giving speeches recently, trying to spell out their thinking on capital more clearly.
"This danger of creating uncertainty exists because we are finding our way in a new and difficult area of policy," Bailey said.
The FSA is still requiring banks to build up their core Tier 1 ratios -- a benchmark of a bank's health -- in line with new global Basel III minimum capital requirements from January.
Bailey said where banks are being given latitude is in scaling back on capital they hold above the regulatory minimum, know as Pillar 2, and set at the discretion of supervisors.
Since 2008, this type of capital that sits on top of the regulatory minimum has risen from just under 20 billion pounds to 150 billion pounds.
Investors have shunned bank shares as lenders fail to make the heady returns on equity seen in the run up to the financial crisis.
The market value of many UK banks reflects this discount, falling to below its book value of tangible equity capital, which could suggest the need for more capital.
Bailey said there was a need to find out exactly why this was the case, urging input from analysts and banks because if the issue was not cleared up quickly, new lending to the economy could be hit.
"This is the immediate task ahead because we need to do all we can to clear up uncertainty here."
Bailey was not unduly worried about forebearance or where banks opt to renegotiate the terms of a struggling loan, saying although this can mean painful restructuring for the borrower it also helps preserve jobs.
Some policymakers want banks to avoid too much forebearance and instead make speedy provisions for losses so that investors have a clearer snapshot of what's happening.
"Let me say something unusual now: I think that the banks deserve a thank you for the way in which they have sought to use forbearance," Bailey said.
Reporting by Huw Jones; Editing by Dan Grebler