By David Milliken and Huw Jones
LONDON (Reuters) - The Bank of England took steps on Friday to keep banks lending through 2021 as Britain copes with the COVID-19 pandemic, saying it was ready to deal with any market disruption from a big change in the UK's trading relationship with the European Union.
Governor Andrew Bailey said Britain had done all it can to mitigate risks from a no-deal departure from the EU on Dec. 31, and it was ready to deal with any disruptions to financial markets.
"What has the Bank of England got in its armoury, as it were? The answer is a lot. We will use our tools, as we did in March, should we be in that situation," Bailey told a news conference.
Market disruptions would not threaten financial stability, but Bailey warned that some EU customers might not be able to get access to UK financial services because the EU has not taken mitigating action.
"There is a limit to what we can do," Bailey said.
Market volatility could be reinforced by some derivative users not being fully ready to trade with EU counterparties or on EU or EU-recognised trading venues, the BoE said.
"Financial institutions should continue taking measures to minimise disruption," it said.
The central bank said the counter-cyclical capital buffer - extra money banks must set aside during economic good times - would be held at zero until at least the last quarter of 2021.
Banks would not need to implement any future change until the end of 2022, and should use this flexibility to underpin lending to the rest of the economy, the Bank of England (BoE) said.
On Thursday, the BoE announced it would allow banks to restart paying dividends and executive bonuses.
"Our message today is that the financial system has the resilience to go on doing that," Bailey said.
Banks would face challenges next year from higher unemployment and business insolvencies but were well prepared, the BoE said.
"The major UK banks can absorb credit losses in the order of 200 billion pounds, much more than would be implied if the economy followed a path consistent with the Monetary Policy Committee's central forecast," the BoE said.
The BoE forecast last month that Britain's economy would shrink by 11% this year as a result of the pandemic and grow by 7.25% in 2021, taking until the first quarter of 2022 to return to its pre-crisis size.
Unemployment was expected to peak at 7.8% in the second quarter of next year.
The BoE also reiterated that it did not plan a post-Brexit relaxation of financial standards.
"Irrespective of the particular form of the UK's future relationship with the EU ... the Financial Policy Committee remains committed to the implementation of robust prudential standards in the UK," it said.