By David Milliken and Andy Bruce
LONDON (Reuters) -Low stock market valuations for Britain's major banks are hard to explain, given that they are safer investments than they were before the 2007-08 global financial crisis, Bank of England Governor Andrew Bailey said on Monday.
Bailey said he disagreed with investors who thought regulators required banks to hold too much capital, or that banks were regulated much more harshly in Britain than in other major jurisdictions.
"One remaining puzzle is the market valuation of the large UK banks, which by the way is not uniform," Bailey said in a lecture at Loughborough University in central England, which did not touch on the outlook for monetary policy.
"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. The cost of equity remains at pre-crisis levels even though it was clearly mispriced before the crisis," he added.
Bank valuations across Europe have been weighed down over the last year by caution about the economic outlook, but some major investors say that has made the sector increasingly attractive.
Bailey said Britain's financial system had remained stable, despite turmoil over the past year - which saw the collapse of the United States' Silicon Valley Bank and UBS' takeover of Credit Suisse (SIX:CSGN) following a loss of investor confidence.
However, this turmoil may have increased the amount of reserves which banks will want to hold with the BoE, to protect themselves against market funding drying up at short notice.
As the BoE reverses its massive quantitative easing programme - which led to banks holding hundreds of billions of pounds of extra cash at the central bank - it has been trying to work out how much commercial banks will still want to hold.
"I expect the future level of reserves to fall from where it is today: 467 billion pounds ($590 billion)," Bailey said.
"I will go a bit further and say that my best guess today is that the demand for reserves by the banks will settle at a level higher than we would even in the recent past have expected. That may be for more than one reason, of which one may well be the lessons of last year," he added.
The BoE's overall stock of reserves - including the 467 billion pounds held by banks - stood at 790 billion pounds last week.
($1 = 0.7914 pound)