In its Financial Stability Report, the Bank says that an adjustment in both the price and quantity of risk-taking was clearly needed after an extended credit boom but it was bound to have costs.
It says: “But estimates implied by prices in some credit markets are likely to overstate significantly the losses that will ultimately be felt by the financial system and the economy as a whole, as they appear to include unusually large discounts for illiquidity and uncertainty.
“In effect, risk premia in some markets have swung from being unusually low to temporarily too high relative to credit fundamentals. That may be contributing to the delay in the return of confidence and risk-taking.”
The report says that the most likely path ahead is that confidence and risk appetite turn gradually as market participants recognise that some assets look cheap on a fundamentals basis.
But it warns that with sentiment still weak and deleveraging continuing, downside risks remain.
It says: “Banks can further boost confidence in their resilience through more informative disclosures and by raising capital as a signal of strength in turbulent market conditions, as some are already doing.
“Further ahead, it is important that banks and the official sector also tackle the underlying sources of overextension of credit in recent years.”
Bank of England financial stability deputy governor John Gieve says: “The unavoidable correction after the credit boom is proving protracted and difficult. However the pricing of risk in credit markets seems to have swung from being unsustainably low last summer to being temporarily too high relative to fundamentals. So, while there remain downside risks, the most likely path ahead is that confidence and risk appetite will return gradually in the coming months.”
“To reinforce those prospects of recovery, we need to restore confidence in the banking system. That is why we have launched the Special Liquidity Scheme and why I welcome the steps taken by some banks to strengthen their capital positions.”