The Bank of England’s Financial Policy Committee (FPC) has reduced its benchmark capital requirement for UK banks to 13% of risk-weighted assets, down from 14%, a move that could provide modest relief to trade finance operations that have faced mounting pressure from regulatory constraints. This comes shortly after the UK Budget, during which Chancellor of the Exchequer Rachel Reeves urged the BoE to implement measures to jumpstart the UK economy.

The reduction, announced in the FPC’s latest Financial Stability in Focus paper, comes as trade finance providers have increasingly found themselves constrained by leverage ratio requirements rather than risk-weighted capital rules – a shift with particular implications for the low-margin, high-volume business of letters of credit and supply chain financing.

The problem is acute for domestically-focused banks that maintain substantial trade finance operations. Three of seven major UK banks now find leverage requirements more binding than risk-weighted measures, following a 7.5 percentage point decline in average risk weights since 2016. This has effectively tightened the constraint on balance sheet expansion, even as the nominal risk associated with trade exposures has remained stable or declined.

For trade finance desks, the challenge lies in the economics of the business model. Documentary credits and similar instruments typically carry low risk weights – often reflecting strong collateralisation through underlying goods and established mitigation practices. Yet these same instruments consume leverage capacity at the same rate as higher-risk exposures, making them less attractive when leverage becomes the binding constraint.

The FPC’s decision to review leverage ratio implementation, with particular focus on regulatory buffers, could prove significant. UK leverage requirements for large domestically-focused banks currently exceed those in the eurozone and the US, partly reflecting the FPC’s decision to apply systemic buffers across both risk-weighted and leverage frameworks.

The committee’s benchmark reduction should translate to approximately £60 billion less nominal capital required across the system, based on current balance sheet sizes.

More promising is the FPC’s commitment to enhancing buffer usability; evidence from the COVID-19 period revealed banks’ reluctance to use non-releasable buffers, even when regulators explicitly encouraged it.

The Bank’s intended review of how different domestic exposure requirements interact – including the countercyclical buffer, systemically important institution buffers, and Pillar 2A requirements for geographic credit concentration – could address longstanding industry concerns about overlapping constraints on UK-focused lending.

UK banks currently maintain approximately £37 billion in aggregate capital headroom above their requirements, suggesting room to expand lending, including trade finance, without immediate capital raises. However, the binding nature of leverage requirements for several major players means this headroom may not translate readily into increased trade capacity.

The implementation of Basel 3.1 in January 2027 should bring further relief, with Pillar 2A requirements expected to fall by approximately half a percentage point as risk measurement improves. For trade finance, with its typically robust collateralisation and risk mitigation, this could prove beneficial if it reduces the calibration of concentration risk add-ons.

The FPC’s revised framework represents cautious easing rather than dramatic liberalisation, but for trade finance providers operating on thin margins, even incremental relief could support continued provision of vital services to UK exporters and importers.