(Bloomberg) -- Regulatory reforms since the 2008 financial crisis cannot be blamed for the sharp discount in UK commercial bank valuations, Bank of England Governor Andrew Bailey said.

In a speech on a visit to the East Midlands, Bailey argued that more reforms are needed to protect banks from runs like the one that broke Silicon Valley Bank UK last year. 

He also dismissed concerns about the UK falling into recession, saying any downturn “will be shallow.” Official figures this week may show the economy contracted in the fourth as well as the third quarter of 2023, but growth now appears to be picking up. 

“What I put more weight on is...the indicators we’ve seen since then,” Bailey told an audience at Loughborough University. The economy is showing “some signs of upturn.”

Bailey said new rules designed to strengthen the financial system following the collapse of Lloyds Banking Group and Royal Bank of Scotland in 2008 have proved a success as “lenders have come through the turbulence of the last four years in sound health.”

However, he said UK lenders will in future need to hold large liquid assets for financial stability reasons. Major UK banks currently have £467 billion ($590 billion) of cash-like “reserves” at the BOE and, while the number will fall, it will settle far higher than the £10 billion they held at the BOE before 2008.

Britain’s banks are trading below their book value, a sign that investors believe they will lose money on their activities. The lenders are also on lower stock market valuations than peers in the US and elsewhere. 

Bailey said it remained “a puzzle” but he wanted “to rebut” the two explanations commonly given. Higher regulatory capital requirements have been blamed but more capital “greatly benefits the stability of the system,” he said. 

‘Broadly Aligned’

He also rejected the argument that other countries’ banks trade at a premium because “requirements differ across national jurisdictions, and this influences valuations.”

“I don’t agree with this argument,” he said. The rules are internationally agreed and while “there will be differences in implementation at the edges, the outcome are broadly aligned.”

Instead, he argued that investors appear not to value the sector’s new-found stability. He pointed to the cost of equity for UK banks, which is the same as before the financial crisis when lenders were so highly leveraged they were financially vulnerable.

“What is immediately apparent is that the cost of risk – the return equity investors demand – does not seem to have fallen in line with what appears to be greater stability and lower risk per unit of equity,” Bailey said.

One remaining risk is that banks today face more severe runs because digital withdrawals are much easier than queuing round the block, as happened with Northern Rock. “What we have now seen is a much more powerful version of that experience,” he said. SVB UK lost a third of its deposits in a matter of hours, which forced it into a rescue takeover by HSBC.

The final piece of the puzzle may be broader liquidity coverage to ensure banks are able to access cash in the event of customer deposit flight. To do so, they should “supplement their liquid asset holdings with efficient and extensive access to the liquidity facilities provided by the Bank of England,” Bailey said.

As a result, the BOE will have to run a much larger balance sheet than it did before the financial crisis. “What is that steady state number for reserves? The trite answer is higher than pre-crisis and probably lower than today. I expect the future level of reserves to fall from where it is today.”  

--With assistance from Irina Anghel.

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