Time to get out of BarCap, RBS and HSBC?

12 September 2011

6 minute read

Time to get out of BarCap, RBS and HSBC?

The Independent Commission on Banking's final report is out. On cue, shares in British banks are down. But they're not down by much.

So is everything ok for investment bankers at UK banks?

Yes. And no.

Yes, it's ok

· It's ONLY ringfencing

Given that the Liberal Democrats were going for a full separation of retail and investment banking, maybe ringfencing retail banking activities and subjecting them to a higher (10%) core equity requirement isn't so bad after all.

In one sense, today's ringfencing requirement is less demanding than expected. The ICB gives banks the choice whether to include large corporate deposits within the ringfence or not. This is good news for the likes of HSBC, which didn't want large corporate deposits ringfenced and will still be able to use large companies' cash deposits to provide capital for its trading activities if it really wants to.

On the other hand, small and medium sized enterprises' deposits do have to be ringfenced. This could be bad news. Last week, analysts at Berenberg said that if small-business and mortgage lending are included in the ringfence then Lloyds, RBS and Barclays would see almost all their excess capital disappear, but wouldn't need to raise any extra.

· It doesn't have to happen for ages

Before the ICB's report was released, an implementation date of 2015 had been mooted. In fact, the ICB says banks should have until 2019 at the latest to implement its recommendations.

Positively, British banks will have plenty of time to raise sufficient capital and make the necessary adjustments. Negatively, the protracted transition period means years of uncertainty and markets are in any case likely to start pricing in the capital cost of the required changes a lot sooner.

· There could be attendant hiring

As we've pointed out before, the ICB's report will create jobs. If you work in project or change management, regulatory consulting, IT or operational risk at any of the UK banks affected, your job should be safe for some time.

Equally, the ICB's report stipulates that the elements of the bank inside and outside the ringfence must be completely separate, implying that any overlap among existing staff working in central risk functions must be eliminated and that staffing of businesses inside and outside the ringfence must be fully autonomous.

No, it's not ok

· This is worse than British banks wanted

The ICB points out that BarCap argued against a strict ringfence in favour of operational subsidiarisation. This was rejected on the grounds that "operational separability alone...leaves all the financial assets and liabilities on the same balance sheet."

Instead of operational subsidiarisation, all financial assets and liabilities not related to retail banking (see page 11 for details) must be completely separate and, 'meet regulatory requirements for capital, liquidity, funding and large exposures on a standalone basis.'

· The new UK capital requirements are far higher than for international rivals

The ICB's report specified that the largest banks (eg. Barclays, HSBC and RBS) must hold extra capital amounting to at least 17% of risk-weighted assets, and that key banks must hold an extra 3% of assets on top of this. By comparison, Basel III specifies a core Tier 1 ratio of just 7.5%.

British banks will need to raise more capital. As analysts at Espirito Santo point out, Barclays' tier one ratio is currently 13.5%, HSBC's is 12.1% and RBS's is 12.9%.

Increased capital requirements will leave British banks at a disadvantage to international rivals and make them far more risk averse than their international rivals. As Evolution analysts pointed out last week, RBS has already reduced its risk appetite in global banking and markets and cited this as one reason why its revenues decreased last quarter. Falling revenues mean redundancies, especially in sales and trading.

· This is going to increase banks' funding costs

The worst news for British banks with investment arms is that the ringfence will substantially increase their funding costs.

On pages 299 and 300 of its report, the ICB looks at how much each banks' funding costs could increase as a result. The verdict is that BarCap and RBS will suffer most, with additional annual costs of 1.2bn respectively. These costs could easily translate into lower pay and redundancies, especially in capital intensive fixed income trading businesses.

Increased funding costs are a particular issue for Barclays Capital. As was pointed out in February, BarCap's return on equity has been historically below its cost of capital. Higher funding costs are not what it needs.

· This is going to reduce banks' profitability

Increased funding costs will not be alone in denting profitability. Overall, the ICB estimates that the cost of implementing its reforms could be up to 7bn annually for the next seven years. That's nearly 50bn in total.

At the same time, a report last week from analysts at Morgan Stanley suggested earnings per share at Barclays and RBS could fall by 22% and 25% by when senior debt is refinanced at higher rates following ringfencing. However, HSBC looks ok: its EPS was predicted to fall by only 1% due to its lower reliance on wholesale debt financing.

As earnings fall, BarCap and RBS will need to look harder at costs. They are also likely to look hard at pay.

· Leverage ratios could be reduced below the international average

Michael McKee, a partner at DLA Piper, points out that the ICB report also made a little- mentioned reference to leverage ratios (on page 9).

"International proposals are that the leverage ratio should be 33%," says McKee. "But the ICB is recommending that this be lowered for systemically important banks."

Although the ICB doesn't stipulate precisely low leverage ratios should be, its intention is clear: for banks like BarCap, RBS and HSBC, they should be below the international average. Given the link between leverage ratios and profitability in investment banking, this will also reduce banks' profitability. And their pay. And their headcount requirements.

On balance, today is not a good day for investment bankers at British banks. Sometime soon, there will be fewer of them and they will be paid less.

AUTHORSarah Butcher

Global Editor

JS
JS
12 September 2011
Suggesting that UK Banks WILL raise capital is simply wrong. The ICB recommends that the 17% level against which Banks must hold additional capital consists of a required 10% CET1 and 7% of 'bail-in' bonds. As it stands, every major UK Bank's Core Tier 1 ratios are already at or above the 10% threshold. They will instead need to issue the appropriate 'bail in' instrument when it comes to refinancing their outstanding debt. The impact will likely be a higher funding cost not additional equity issuance.
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Mi
Mira
12 September 2011
The Commission's report is a distraction from the real changes that need to be made to the modern banking system. It's not enough to simply worrying about making banks safer - we need banks that are socially useful, rather than socially harmful.
The Commission's report completely ignores the most fundamental problems with the modern banking system, such as the fact that:
- When all money is created by banks as debt, this forces the bulk of the population into debt, permanently
- The interest that has to be paid to the banks on the entire money supply results in money and income being redistributed from the poor to the rich, from the real productive economy to the financial sector, and from the rest of the UK back to the City of London
- That banks must always be rescued by the taxpayer simply because the 85k government guarantee on bank accounts ensures that it will be more expensive to allow a bank to fail than to rescue it
- That the structure of the banking system results in banks being subsidised by the taxpayer between 30bn and 100bn a year (depending on what you include in the analysis)
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Sm
Smart
12 September 2011
Banking is a sinking ship, those smart enough have already exited the industry.
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