How big is the 'material' hole in banks?

The Bank of England The Bank of England has said that banks need to raise more capital.

As I said it would yesterday, the Bank of England's Financial Policy Committee (FPC) has declared that big British banks need to raise more capital as protection against possible future losses.

But it has not cleared up the question of quite how much extra capital will be needed, how it should be raised and precisely when.

There are three reasons identified by the FPC for why the banks are not strong enough:

1) They are under-estimating the potential losses on loans to financially challenged borrowers, households and businesses, especially loans in forbearance (loans where the banks have temporarily eased cash payments - again see yesterday's column for more on this);

2) Banks may be hurt by further big fines or compensation payments relating to their past sins (the mis-selling of PPI or alleged LIBOR rigging, as just two examples);

3) Big banks' discretion to set their own risk weights for different categories of loans under the Basel rules may mean they have systematically understated the riskiness of entire categories of lending.

How much extra capital do the banks need?

Well that will be determined by a supposedly swift probe by the Financial Services Authority - but the Governor Sir Mervyn King said the hole needing to be filled would be "material".

For what it's worth, which is probably not a lot, the Bank of England and Financial Services Authority estimate that Barclays, HSBC, Lloyds and Royal Bank of Scotland would collectively be deficient of capital to the tune of between £5bn and £35bn, if they were all forced to use the same minimum risk weights on their loans.

However, the precision of this calculation is somewhat to be questioned because it is based on 2011 data and also because it excludes the banks' huge financial trading activities.

Or to put it another way, that range of £5bn to £35bn - broad as it is - might overstate or understate the true picture.

More definitively, the Bank of England says that the banks will not be able to fill the capital hole through retaining earnings, or via the profits they generate.

The options

So there are only three options: they can raise capital from investors; they can dispose of assets, where they have assets worth more than book value; or they can boost the ratio of capital to assets by refusing to roll over loans as loans fall due for repayment and by refusing to provide incremental credit.

Here, of course, are the economic and political risks of the bald statement that the banks are capital poor.

In the case of raising capital, the Treasury is making it crystal clear that it does not want taxpayers to put a bean of new money into Royal Bank of Scotland or Lloyds, the banks where the state has holdings of 80% and 40% respectively.

These banks may be able to raise some money by selling loss-absorbing debt to other investors. However that would probably not be sufficient.

So what about selling assets?

Well both banks are already engaged in huge asset sales forced on them by the European competition authorities.

For RBS in particular, there is a stark probable consequence of the Bank of England's capital prescription: it may well have to sell its relatively successful US retail operation, Citizens Bank; and it could be forced to pull out of investment banking more-or-less completely.

So what about the big question of moment to all of us: will the banks lend more or less as a result of today's announcement?

The governor of the Bank of England believes that once the banks are adequately capitalised, they will at last start providing sufficient credit to deserving households and businesses. Banking theory suggests he is right.

The problem is that until banks have all the capital they need, and as I have already mentioned, all the banks will be sorely tempted to boost the ratio of their capital to assets by lending less, to shrink the denominator in the calculation.

Or to put it another way, telling banks they have to raise material amounts of capital - without telling them how much capital and setting a deadline from them to find it - may have the perverse and damaging consequence of contracting the amount of credit supplied to the economy, and knocking economic recovery yet again.

That said, the Bank of England has tried to take pre-emptive action against this so-called deleveraging - by saying that new lending to households and businesses, under the Funding for Lending Scheme, will not attract any capital charge. So, in theory, if banks go on a lending strike, they will be cutting off their respective noses to spite their own faces.

Even so, it is moot whether banks really will feel like taking on the real credit risks of lending more to small businesses, for example, when they are being lectured by Sir Mervyn that they have been understating the risks on their historic lending.

And what does all this mean for the prospects for privatising Lloyds and RBS?

As a precursor to privatisation, both banks felt they had to start paying dividends again. And if they have to conserve and increase capital, the chances of dividends resuming in the coming two or three years has diminished very considerably.

Both banks had hoped that privatisation would begin in 2014 or 2015. But Sir Mervyn and his colleagues on the FPC may today have engineered yet another significant delay to the moment when taxpayers can celebrate severing the ties that bind us to Lloyds and RBS.

Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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  • rate this

    Comment number 110.

    @104 lol4caust
    Am sorry for your situation & am angry about it too but it was not just the banks. It was the most perfect of econo-storms w/multi-causes.

    And wrecking system will be worse. Mad Max was worst sort of kleptocracy situation if I recall! ;-)

    We need massive reform in UK; spiritual, political, economic, fiscal, social ...

  • rate this

    Comment number 109.

    Till we kill off the Zombie banks we will not get an economic revival. As the zombie banks are financing zombie property companies who are unable to even repay the interest on their loans - even at near zero interest rates. This perverts the whole economy as it deprives good business access to properly priced property from which to trade. (Ditto for house prices)


  • rate this

    Comment number 108.

    Thinking bout yr interest post a bit more brings to forefront 1 thing that troubles me: current inefficiency of CivService. As such it costs UK a lot of money that 'we' have earned. 2 exs in last 2 weeks of HO failings at borders.

    So, in a way HMRC being efficient is a sort of 'earner' for UK. If they let tax collect slip, ord tpayer has to pay more&there is less for economic generation.

  • rate this

    Comment number 107.

    @106 Bluesberry.

    Ah "shadow banking" at its finest. Dont worry all the banks are at it. At least drug money comes from a real and tangible asset and a real economy where real goods change hands. Dare I say it the sort of area banks should be operating in rather than that of CDO's and derivatives
    As for America proud banking system I think Wachovia and Wells Fargo have already been caught.

  • rate this

    Comment number 106.

    Digging their own HOLE:
    E.G. HSBC is set for FINAL BILL (as high as 937m pounds) for shameful US money-laundering scandal. HSBC is expected to spell out financial damage. Bank accused of leaving America’s financial system exposed to Mexican drug cartels & rogue nations such as Iran by failing to enforce US anti money- laundering laws.
    Under-capitalized or digging own HOLE?

  • rate this

    Comment number 105.

    Right up to a point except that at start and in modern times banks have been right at forefront of helping others earn. In middle period they were bit more laid back! For sure, they take their cut. In 16&17c it was at the end; in 1960> it was increasingly at beginning as well. Hence my econo stance that continual cost of living incr by Govt+bonus culture has created great distortion

  • rate this

    Comment number 104.

    @102 Sitting awaiting bankruptcy and repossession watching the country be looted. Watching the banks desperately trying to keep property prices afloat helped by every bit of cheerleading media they can muster. I am not prepared to see the mistakes repeated ad nauseum in another 50 years. Let them fail let our political system tumble a mad max dystopian system brings more hope that this kleptocracy

  • rate this

    Comment number 103.

    Banks may be hurt by further miniscule fines or compensation payments relating to their past sins (like mis-selling of PPI or LIBOR rigging). How? The fines have been so miniscule & no one has gone to prison.
    How much capital should a bank hold?
    Depends on how much risk politicians & investors are prepared to take = debate that can never be finally resolved.

  • rate this

    Comment number 102.

    @89 U-U
    We have all lost & suffered & suffer ...

    ... but ...

    ... it could be a lot worse.

    1m bankers + ?m service suppliers unemployed
    Billions more in tax reqd from other 'industries'
    All those industries hit by lack of finance, export guarantees, leasing, easy foreign exchange.

    Worst case scenario but do you really want that?

  • rate this

    Comment number 101.

    The hole in banks balance sheets is their "total assets" minus the approximately 8% of tier 1 capital they actually hold. Anything more or less is smoke mirrors and bluster.

    Pop goes the weasel

  • rate this

    Comment number 100.

    Robert, you suggest that some banks may well refuse to rollover loans as they become due for repayment.
    May, most are and have been doing so as far as property loans are concerned for a couple of years. They tend to concentrate on the loans that they feel can be refinanced which will over time leave them with “interesting” loan books.

  • rate this

    Comment number 99.


    All banking is a service and as such wealth has to be created elsewhere before they can take their cut ,well thats how it should be....we now know otherwise .

  • rate this

    Comment number 98.

    well said # 90. hang your heads in shame Angela Knight, Lord Turner, Fred Goodwin and all the rest. your names will go down in history for either bringing the UK to its knees or not noticing how it got there. Five years later and the stuff is still hitting the fan. Now its a £60bn black hole in underestimated doubtful debts and dubious selling. And
    what will it be when t property bubble bursts?

  • rate this

    Comment number 97.

    This is a truly sad story of ever decreasing circles and ever increasing pain for the average taxpayer/consumer.
    A lot of this was fuelled by stupidly priced housing and the belief that the value will always go up.
    House prices need to fall by at least a 1/3 and interest has to get back to it's pre crash long term average of ~3% or thereabouts.
    (Putting some bankers in jail would probably help)

  • rate this

    Comment number 96.

    #95 that is going to be a very trickey ? BUT it might have 2 b addressed

    those since 1997 would be a start then

    Nick clegg and his wife for starters as well

  • rate this

    Comment number 95.

    1 Hour ago
    Which immigrants? My parents who have lived here for 50+ years? Or maybe my mutli qualified partner who has paid a handsome contribution to the University budget.
    Nick Clegg's Wife?
    Nigel Farage's Wife?

  • rate this

    Comment number 94.

    No because their job is collecting (a share of already) earned money.

    Economies change over time, and various bits of news often disguises or distorts reality.

    Of interest to me w/current state of UK econ:
    >Importance of oil & gas despite so-called decline
    >Importance of tourism
    ... as well as financial services.

  • rate this

    Comment number 93.

    Emperors clothes
    Now this is entirely unfashionable thing to say but making banks hold more capital is ENTIRELY the wrong policy at THIS point in the cycle but no one " in charge" is brave enough to say it. Current policy results in less lending and causes banks not to restructure over indebted customers which creates Zombie companies who cannot invest , grow and contribute to economic recovery.

  • rate this

    Comment number 92.


    Is this not like saying HMRC are the biggest contributors to the British economy then ?

  • rate this

    Comment number 91.

    just nonsense
    banks do not lend their own assets to households and firms
    if banks are holding non performing loans
    and cannot rip customers off with unnecessary loan accompanying
    products they have to tighten their lending criteria
    if the assets they own or reposess fall in price they are in trouble
    or others cannot pay up on a hedge
    with private sector balance repair
    fiscal stimulus only option


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