New shocks may emerge, Old Lady warns

Equity prices, the Bank said, "could be vulnerable to any further revision in growth prospects."

The Bank said that its credit conditions survey for the third quarter (http://subscription.centralbanknews.com/item.asp?itemid=29049) had shown lenders were tightening and would continue to tighten lending for commercial real estate. Inflation has already fallen and a sizable development pipeline has, the Bank said, "raised the potential for future overcapacity."

The recent change in investor sentiment towards US securities would lead to a depreciation of the dollar if it continued, the Bank said.

Lessons

The Bank acknowledged that the Northern Rock crisis had "exposed shortcomings in UK crisis management tools" and labelled the existing deposit insurance system limited. The Bank also criticised the lack of a special insolvency regime for banks and gaps in international arrangements for managing stress.

The Northern Rock crisis "highlighted starkly the risks associated with the high dependence of some banks on wholesale funding markets" and said a review of the resilience of contingency liquidity plans needed to form part of the tripartite committees stress testing.

The Bank said that it, along with the Financial Services Authority and the Treasury, had monitored Northern Rock's problems since 14 August but had resisted intervening until the prospects of a successful securitisation or takeover faded.

The valuation of complex financial instruments needed to be reassessed. The Bank said the crisis showed "the dangers of using ratings as a mechanical input to their risk assessment".

To read the report, click here [http://www.bankofengland.co.uk/publications/fsr/2007/fsrfull0710.pdf]