The Bank of England has encouraged banks to keep lending to viable businesses to ensure companies have enough credit to survive the crisis after it found UK banks are "strong enough" to keep supporting households and firms.
The BoE said it is in the banks’ "collective interest to continue to support viable, productive businesses", rather than "defend capital ratios" by reducing lending just as the UK slowly starts to ease itself out of Covid-19 restriction measures.
“Cutting lending … would have an adverse effect on the economy and therefore could have an even greater negative effect on banks’ capital ratios," the BoE’s Financial Policy Committee (FPC) said in a summary of its March meeting.
"If these businesses are not able to meet their financing needs, this could deepen the economic stress and trigger losses for banks on their loans."
The lender said Britain’s banks have very high levels of capital that would allow them to “absorb very big losses while continuing to lend”.
“Since the start of the pandemic, we have safely reduced the cushion of capital that banks need to hold to absorb potential losses. This means banks have more capacity to lend,” the BoE said.
Britain's economy contracted almost 10 per cent in 2020, its biggest slump in 300 years after the pandemic forced the closure of offices, shops and businesses to help curb the spread of coronavirus.
Britain's government is due to close emergency lending schemes to new applications this month, as the economy looks towards recovery once restrictions are fully lifted in June.
The BoE said businesses raised substantial funds from banks and financial markets last year “to weather the economic disruption”. With the support of government guarantees, they borrowed almost £90 billion ($123bn) in 2020, compared with £20bn in 2019.
“Businesses will need further support in the months ahead even as the UK economy recovers," the BoE said.
“Covid continues to put a big strain on UK businesses’ earnings, and is threatening the livelihoods of many people. Vaccines should help the UK economy recover rapidly later this year."
The lender said the Brexit transition period ended with “minimal disruption to financial services” thanks to the “extensive preparations” UK authorities and the sector made in the four-year run up to Britain’s final exit from the EU.
The BoE said it remained committed to working closely with EU authorities on creating “a safe and open financial system”.
The lender also flagged instances of illiquidity as a broader risk to the financial system after a rout in some government bond markets pushed yields higher.
In a routine assessment of threats, the FPC said vulnerabilities in the market remain almost a year after they first emerged during a sell-off at the start of the coronavirus pandemic.
“In February, the fragile nature of liquidity in some government bond markets had been evident during a period where advanced economy government bond yields had risen markedly,” the BoE report said.
“The FPC judged that recent experience showed the fundamental vulnerabilities in market functioning that had been exposed during the ‘dash for cash’ remained and could amplify any further repricing.”