Banks ‘need more capital’ - but when?

Bank of England

The Bank of England's Financial Policy Committee will tomorrow provide more enlightenment on a question of serious importance to the banks, the government and all of us - which is how much additional capital the banks need to raise, and when, to cover the risk of losses on loans to borrowers who may struggle to repay.

For what it is worth, I have been told two seemingly contradictory things.

First that the FPC - set up by the government to pre-empt and prevent future financial crises - will be explicit that the banks need to build up their capital buffers, to cover the "general" risk of a future "general" spike in losses.

The important technical point - as you may have noticed by my annoyingly liberal use of speech marks - is that these are "general" capital buffers, or capital that is additional to what banks are forced to hold by Pillar 1 of the Basel rules (oh yes) to cover the measurable risk of loss on "specific" loans (and bravo to those of you resolutely wading through this stuff - I would argue it matters to all of us, because it goes to the heart of whether banks are strong enough to support the needs of the economy).

Second, any such pronouncement by the FPC won't lead to taxpayers being forced to put yet more money into Royal Bank of Scotland or Lloyds - or at least not immediately, in any case (such are the noises from the Treasury, which really ought to know what's going on).

Now it is not clear to me how these two statements can be consistent.

Because if RBS, for example, is forced along with the other banks to reinforce its capital buffers to a significant extent, it is difficult to see where this capital can come from, if not taxpayers: with RBS 80% owned by the state, and with its share price still relatively low, the bank could not raise significant sums of equity from conventional investors.

So, to state the obvious, there is obviously something I don't know about what the FPC will say tomorrow.

Perhaps the FPC will initiate a formal process of assessing each bank, to verify whether in this general sense they have enough spare capital to absorb potential losses on loans more susceptible to being significantly impaired as and when borrowers face hardship.

Now arguably the most resonant and important category of such loans are those in forbearance or on the cusp of forbearance. These are debts where the banks have temporarily eased payment terms - perhaps by making them interest-only debts or by rolling up the interest into the principal - because borrowers are seen to be facing temporary financial hardship.

Research by the Financial Services Authority indicated that between 5% and 8% of mortgages are in forbearance together with a third of commercial real estate loans.

Of course, the banks have already set aside incremental capital against loans in forbearance. But it is not clear whether they have made adequate provision for the worst that could happen.

To put it another way, there are tens of billions of pounds of loans made by British banks, whose quality is low and where there is a higher-than-average probability that they will never be repaid in full. And the question haunting the regulators and investors is whether banks hold enough capital to withstand the losses, just in case a big proportion of loans in forbearance have to be written off.

But there would be something of a problem with a review of whether individual banks have adequate general protection. It could be a messy and elongated process, and could have precisely the opposite consequence to that desired by the FPC - because it could encourage banks to stop lending, to the detriment of the economy, as they attempt to massage up the ratio of their capital to assets.

As it happens, the earlier pronouncements of FPC members would indicate they would prefer a short, sharp shock of rapid capital raising - either through banks asking their owners and other investors for more money or the banks selling businesses worth more than their book value.

Why? Well the big point of forcing banks to increase their capital buffers would be to give them confidence that they have protection against whatever storms lie ahead - so that they would not have to be so penny-pinching and reluctant to provide the loans badly needed by healthy businesses and households.

Or to put it another way, it would once-and-for-all put to bed the notion that some of our banks are in effect "zombies" - with enough capital to just about keep going, but not enough to fulfil their essential function of creating the credit necessary for the UK's economic recovery.

But, again, to expose the glaring gaps in my knowledge, if the FPC announces such a short sharp shock of capital raising, it is very difficult to see how that can be done without RBS in particular - and perhaps Lloyds too - becoming even more nationalised than they are.

And that is something the Treasury neither expects or wants.

So it is all a bit puzzling.

By way of postscript, however, there is an important philosophical point here, which is that the FPC wants the banks to be less mechanistic in the determination of their respective capital needs and to exercise more judgement.

This would represent a cultural revolution, a process of going back to the future, because bankers would have to put at the forefront of everything they do not the maximisation of short-term profit as a percentage of capital, but the reinforcement of the foundations of their institutions to withstand more-or-less any earthquake.

PS If you are up for a bit more punishment, here is some stuff I made earlier on the tension between strengthening banks and encouraging them to lend: Have regulators deepened the recession? and King: 'no recovery till banks raise capital'.

Robert Peston Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 210.

    @192 A seditious Malcontent

    Taking figure 4 as an example -- and I believe that is what it is today -- we can see the inherent problem. If at any stage a borrower can no longer repay their debt (almost certainly due to the interest imposed without regard to economic climate) their particular spoke breaks and the wheel falls of the cart. The drive for profit drives the vehicle into disrepair.

  • rate this

    Comment number 209.

    @182 treacle_01 (previous should have read @178)

    It's the overly complex many-to-many-relationships that are a key factor in bank failings. A one-to-one form of banking (which it mostly was up until recent times) would be safer for us all; no more economies being taken down by trader in another country. Modern technology would help us, and FRB is a deception: still.

  • rate this

    Comment number 208.

    @182 treacle_01

    I know I state a simple truth, but that simplicity is at the core of finance: it is its foundation. A stronger more interventionist form of regulation seems equally simple in its position. We know that self-regulation doesn't work, and we know that light touch regulation doesn't either. But unlike, Apple what the banks do affects the lives of each and everyone of us.

  • rate this

    Comment number 207.

    @206 UD
    Sorry, there you have lost me.

    Do you have specific info that lots of MPs have cash overseas? Or is it one these legends: grain of truth but assumption that problem is huge is wide of mark.

    I don't doubt that once you reach a certain inc level, then spare cash gets moved around a lot - or - more likely put in investment funds that do the moving.

  • rate this

    Comment number 206.

    For sure up2snuff - but PAYE earnings won't be 3/4 of the amount ;-)

  • rate this

    Comment number 205.

    @203 UD
    Not so sure myself. Remember, in Mar&Apr we are told all h/rate t'payers avoid 50%. Then in May we discover 3/4s pay via PAYE!

    Think where we will see some action&maybe get some law is as western European&US govts face continued decline in tax revenues but want to go on spending money.

    There has already been one attempt post-2007 w/HMRC seeking declaration of o'seas int bearing deps

  • rate this

    Comment number 204.

    'If you are up for a bit more punishment, here is some stuff I made earlier on the tension between strengthening banks and encouraging them to lend: Have regulators deepened the recession? and King: 'no recovery till banks raise capital'.
    Govt should not micro manage
    Banks should make prudent lending for reasonable return
    GO & MK should raise interest rates.

  • rate this

    Comment number 203.

    #202 Up2snuff - I imagine quite a few MPs of all parties have plenty of funds tucked away off-shore so I don't expect it to happen any time soon ;-)

    I would like the entire process involving offshore banking to be reviewed tbh.

  • rate this

    Comment number 202.

    @201 UD
    Now that would take real guts on the part of any Government.

    Would it be something that would go against a person's human rights though? Once capital restrictions have been removed can they be put back?

  • rate this

    Comment number 201.

    Just force British residents to relocate their money in offshore accounts into British banks and the banks will be full recapitalised in no time.

  • rate this

    Comment number 200.

    Nope,my fault. Just dealing with bank res. alone w/not be suff for recov&future.

    Internat audit standards s/be devd for all finance mrkts incl third level derivs. Auditors need to up their game as well as BoE inspects. We need to terminate existing individ bonus structure in westn Cos&move to shared bonus where all benefit eq from Co progress.

    In addn Gov needs to get out of way!

  • rate this

    Comment number 199.

    There is an elephant in the room: T

    The new Mortgage Market Review tells lenders to flex rates by “a min of 1%” (read exactly 1%) to test affordability. Given loans are 25 yrs and rates have been 10%+, how can flexing a 2% rate to 3% be called rigorous testing?

    The FSA “gets tough”, new rules ignore "normal" interest rates and we all keep dancing for a year or two more. Scary stuff..

  • rate this

    Comment number 198.

    Bobby's next post:

    Looks suspiciously like a discussion on FRB...

  • rate this

    Comment number 197.

    196. macduggie "a debt jubilee" = a 50 year depression as Capitalism is reset (and riots!)

  • rate this

    Comment number 196.

    Robert- would a debt jubilee explain how banks could avoid UK loans defaulting without the banks themselves receiving taxpayers' money? Maybe ask around, see if that's the plan...

  • rate this

    Comment number 195.

    This seems to be the inevitable consequence of the risk-weighted lending model the banks you use, as you blogged about here:
    As usual the banks' greed precedes what ought to be their downfall, but which in our state-protected corporatist world will lead to more squeezing of the only source of money there really is in the world - us! The little people.

  • rate this

    Comment number 194.


    @190. yes


    I think that, after a period of non-intermediation, someone would then come up with the bright idea of creating a risk intermediator.

    Then they might just come up with the name "bank".

  • rate this

    Comment number 193.

    @189 "I was suggesting that FRB as normally discussed is a 'fishy' doctrine, misused by people with a certain axe to grind. I think consideration, discussion & promotion of it should be avoided for that reason"

    That's very big of you. Seriously? you want to decide what can and cant be discussed? How long have you been a lobbyist?

    @190. yes

  • rate this

    Comment number 192.

    "I meant nothing by it"

    I know,no problem.

    Medium of exchange MoE V store of value SoV (I prefer store of purchasing power).As MoE it's a public facility,as SoV it's considered personal property
    As MoE it must circulate for the economy to function, link case studies show how hoarding or lending affects stability

  • rate this

    Comment number 191.

    @189.Up2snuff - Ah! I see what you were getting at now - so apologies from me too for misinterpreting. A 1000 character limit would be so much better!


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