The Bank of England has unveiled plans to relax key capital requirements for UK banks, despite concerns from some officials that this move could heighten risks within the financial system.

On Tuesday, the central bank's Financial Policy Committee, which oversees financial stability, stated it would lower the leverage ratio. This ratio restricts bank borrowing by setting a minimum level of capital that banks must hold.

This initiative is designed to encourage lending and support the functioning of financial markets during crises. It represents the latest step by regulators to unwind restrictions imposed on the banking sector following the 2008 financial crisis.

The Financial Policy Committee indicated that this adjustment would reduce the overall leverage ratio for the UK banking sector by approximately 0.2 percentage points.

The central bank added that, combined with plans to ease other bank capital rules during stress periods, this would "make it easier for banks to use capital to support lending and the functioning of core markets under stress, while maintaining broad alignment with international standards."

However, the institution noted that "some FPC members were concerned that the proposal could lead to an unintended increase in market leverage, with implications for the resilience of UK core markets," and it plans to explore "potential mitigants."

The central bank stated that vulnerabilities in the financial system have "become more evident" in recent months, including "increased use of leverage in equity markets," which has contributed to soaring share prices. These measures were taken in response.

In its semi-annual Financial Stability Report, the Bank of England said, "Despite a challenging global risk environment, equity valuations remain elevated relative to earnings by some measures."

The report noted that rapid share price gains for companies linked to artificial intelligence have pushed the valuation of the leading US index, the S&P 500, relative to its earnings to "levels not seen since the bursting of the dotcom bubble in 2000."

The Bank of England stated that "the risk of a sharp correction in equity markets remains elevated." It further added that over the past year, debt provided by investment banks to hedge funds for leveraged bets on equities has grown by 40% to a record high.

The central bank also warned that the rapid development of frontier artificial intelligence capabilities "raises financial stability risks associated with cyber security and operational resilience."

The bank expressed concern over historically high government debt issuance, extensive use of debt by hedge funds to bet on government bond markets, and growing risks in private credit markets. It added that it is "particularly concerned that many of these vulnerabilities could crystallise at the same time."

The Bank of England outlined its plan to reform UK bank capital requirements, stating its aim is to make them "simpler, more effective, more proportionate and better adapted to the risks in today’s financial system," while ensuring resilience in a crisis.

The report pointed out that larger, domestically-focused banks—Lloyds Banking Group, NatWest, Nationwide, and Santander UK—would receive relief during crises. Specifically, it clarified that the additional capital buffer for "other systemically important institutions" could be reduced to zero in stress periods. Public consultation on this change will occur later this year.

Another key part of the plan involves relaxing the leverage ratio requirement for UK banks. The leverage ratio is a crucial safeguard metric that prevents banks from becoming overly reliant on borrowed funds.

The bank said it would also increase the "releasable" proportion of the leverage ratio during stress periods, enabling banks to maintain lending levels during times of financial strain.

Changes to the leverage ratio rules are expected to benefit UK banks with a more domestic focus to a greater extent than global lenders with larger investment banking operations, such as HSBC, Barclays, and Standard Chartered.

Overall, the Bank of England stated that these changes would "reduce the aggregate leverage ratio requirement for the major UK banks subject to it by around 20 basis points, with the impact varying across banks."

This move follows US regulators' decision to ease leverage ratio rules earlier this year, which led several of Wall Street's largest banks to report a decline in their capital levels relative to total assets in the first quarter.