‘Honest’ assessment of hidden losses sparks row with business secretary Vince Cable – who argues banks should not be forced to raise fresh capital in recession
Bank of England policymakers have warned that UK banks need to find additional capital of £25bn, immediately sparking concerns by the business secretary over the potential impact this might have on lending to the struggling economy.
The banks and building societies with shortfalls were not identified but have until the end of the year to plug the gap, left after some banks were found to have underestimated the amount of capital they might need by £52bn.
The capital could be required to cover bad loans, mis-selling claims and other risks – although the banks have already produced plans to raise half the sum needed.
The taxpayer will be able to avoid pumping in more cash on top of the £65bn already ploughed into Royal Bank of Scotland and Lloyds Banking Group, although the focus still turned to the two bailed-out banks.
RBS shares were among the biggest fallers on the FTSE 100 on the day as analysts calculated that the 82%-taxpayer owned bank had the largest shortfall, although shares in others were steady after months of speculation about the size of the total shortfall, which policymakers had estimated could be as high as £60bn.
Banks have produced business plans to fill half the shortfall by selling off businesses, holding on to profits rather than paying dividends and bonuses, and cutting the risks being taken. RBS insisted its capital position was “strong”.
But Vince Cable, the business secretary, criticised the need for banks to raise fresh capital. “The idea that banks should be forced to raise new capital during a period of recession is an erroneous one,” Cable told Sky News.
“I believe the weight of the argument is in favour of counter-, not pro-cyclical, lending measures, and I rather suspect that the new governor of the Bank of England shares this view,” he added.
Sir Mervyn King, governor of the Bank, will be replaced by Canadian Mark Carney in three months. King insisted that the measures would boost lending, not cut it. “Far from reducing lending, today’s recommendations will support lending and promote growth. A weak banking system does not expand lending. The better capitalised banks are the ones expanding lending and it is the weaker capitalised banks that are contracting lending,” King said.
“The shortfall of capital, which the FPC has identified today, is not an immediate threat to the banking system and the problem is perfectly manageable,” the governor added.
The announcement on Wednesday by the central bank’s financial policy committee (FPC) – set up to prevent a fresh crisis in the financial system – found that banks were overestimating their capital by around £52bn. The FPC reached this calculation after looking at losses on high risk loans, particularly commercial property and the euro area, the future bill for compensation claims for mis-selling scandals such as payment protection insurance and the way international capital rules allow them to make judgments about the riskiness of loans, known as risk-weighted assets. The FPC said that losses over three years on high-risk loans could exceed provisions by £30bn, mis-selling bills could cost an additional £10bn and £12bn of capital might be needed if the way banks’ assessed their risks were altered. This comes to a total of £52bn, which the FPC rounded down to a “£50bn reduction in the regulatory capital of the major UK banks and building societies”.
The City had been waiting for the outcome of the FSA’s review, which began at the end of November, after the last quarterly FPC meeting. The FPC has now recommended American-style annual stress tests from 2014 onwards and said that those banks with “concentrated exposures to vulnerable assets” should be required to hold even more capital.
The FPC is also creating a dilemma for banks which under accounting rules must provide for bad loans on losses they are certain will occur – while the FPC wants information about losses they can realistically estimate could occur.
It is far from clear when individual banks will publish the outcome of their reviews, which will be completed by the new Prudential Regulation Authority (PRA), being set up next week to look at the amount of capital banks hold.
Andrew Bailey, the new head of the PRA, said that around half of the capital shortfall is already in banks’ plans. “We are not saying that those plans are absolutely baked in and have been given a seal of approval. They will be scrutinised by the PRA. But if you add the numbers that is where you get to,” Bailey said.
The FPC based its assessments on banks holding regulatory minimum of 7% of core tier one capital – some £250bn is already being used as a cushion across the industry – although analysts noted that banks would eventually need a ratio of more than 10%.
“We understand that the PRA will meet with the UK banks over the next few weeks in order to explain the extent to which they are undercapitalised and agree a strategy for addressing this. Consequently, we expect a cloud of uncertainty to hang over domestic UK bank shares while the market awaits the outcome of this process,” said Gary Greenwood, analyst at Shore Capital.