By Huw Jones
LONDON, Aug 6 (Reuters) - Britain's banks hold enough capital to keep on lending to the country's companies and also to absorb billions in losses likely to arise due to the COVID-19 pandemic, the Bank of England said.
Companies could suffer a cash flow deficit of up to 200 billion pounds ($263 billion), and banks could be hit by credit losses of less than 80 billion pounds, the BoE's Financial Policy Committee (FPC) said on Thursday.
"It remains the FPC’s judgement that banks have the capacity, and it is in the collective interest of the banking system, to continue to support businesses and households through this period," the FPC said in its Financial Stability Report.
"That said, the banking system cannot be resilient to all possible outcomes ― there are inevitably very severe economic outcomes that would challenge banks’ ability to lend."
But there would be costs to banks and the wider economy from taking "defensive actions" like scaling back on lending.
Separately, the BoE said it expected Britain's economy to take longer to get back to its pre-COVID-19 pandemic size.
The FPC said a "reverse stress test" of lenders showed that to deplete their capital ratios by more than 5 percentage points, banks would need to incur credit impairments of around 120 billion pounds.
It would require the cumulative loss of economic output due to COVID-19 to be twice as big as the Bank's central economic projection to incur such losses, the FPC report said.
The FPC has been asked by the finance ministry to review whether changes are needed to Britain's financial system, including regulation, to improve the flow of finance to all parts of Britain.
Britain's government has said it wants to "level up" the regions where investment and productivity lags that of London.
"The FPC intends to focus on examining possible distortions to the supply of illiquid long-term and equity-like investments," the report said.
Although Britain left the European Union in January and transition arrangements end in December with no new UK-EU trade deal yet in place, the report said "most risks to UK financial stability that could arise from disruption to cross-border financial services have been mitigated".
This was the case "even if the current transition period ends without the UK and EU agreeing specific arrangements for financial services," it added.
($1 = 0.7595 pounds)
(Reporting by Huw Jones; Editing by Kevin Liffey and Alexander Smith)