British Banks Still Under Pressure

The Bank of England (BoE)’s last financial stability report in November 2012 re-awakened concerns by revealing additional capital needs estimated at between £20bn and £50bn.

In the wake of the crisis, the authorities intervened on a massive scale, injecting funds and taking stakes in the weakest banks.

However, the stress tests carried out in 2011 by the Financial Services Authority (FSA) and the EBA did not reveal any need for additional capital.

The report’s conclusions cannot conceal the dichotomy between internationally diversified banks and those rescued by the authorities, which remain heavily exposed to the domestic economy.

At the end of November, the Financial Policy Committee (FPC), the body responsible for financial stability, asked banks to make up any capital shortfall quickly. The conclusions of its report stand in contrast to the results of the 2011 stress tests which suggested that British banks were equipped to meet the solvency criteria under new national (Vickers) and international (Basel 3) regulations.

Worries about the financial soundness of the banking system are far from completely dissipated In its financial stability report published at the end of November 2012, the BoE re-awakened concerns about how properly to calculate banks’ capital. The FPC believes that the results of the stress tests suffer from a positive bias that, in its opinion, tends to i) overestimate the value of banking assets; ii) underestimate contingency provisions; and iii) understate risk-weighted assets.

This leads to an additional capital requirement estimated by some analysts at between £20bn and £50bn. First, the BoE recommends that the banks’ capital should reflect a “proper valuation” of banking assets. Given the still fragile macro-financial environment (risk of downturn in residential and commercial property markets, high unemployment rate, weak economic growth, crystallisation of risks in peripheral countries etc), banks could suffer a further rise in the cost of risk and still more significant loan impairments. The BoE’s estimates suggest that the need for provisions to cover expected losses has been underestimated by £15bn. The cost of the various financial scandals has also been only partially recognised by British banks, causing earnings to be reduced if additional provisions are needed to cover future expenses.

Finally, the BoE recommends better valuation of risk-weighted assets, for which the calculation method can vary from one bank to the next. According to the BoE, in Britain’s case greater transparency about calculation methods would be likely to reassure the markets by improving the visibility and comparability of capital ratios among banks. However, the BoE’s assessment should be qualified: i) internal valuation models now reportedly take into account impairment of property assets, following the FSA’s new guidance on risk assessment; ii) current disposals of non-core assets should ease the capital constraint.

BY Laurent NAHMIAS

To Read the Entire Report Please Click on the pdf File Below.