June 28, 2011 10:00 pm

UK banks face pressure to build capital

UK banks are facing increased pressure from regulators to use strong earnings to build up capital ahead of official requirements rather than paying out most of it to staff and investors.

The Financial Services Authority is requiring banks to outline a “flight path” that will put them in compliance with new global Basel III capital requirements, taking into account dividends, bonuses and the potential for another economic downturn.

The Financial Policy Committee, a new arm of the Bank of England, used its first press conference to highlight the need for “opportunistic capital building” last week. Paul Tucker, deputy Bank governor, is expected to hammer home the message on Wednesday in a speech to the British Bankers’ Association.

Sir Mervyn King, Bank governor, had urged banks to build capital buffers above the regulatory minimum. “There will be times when times aren’t so good. And you will then want to be able to run down that buffer in order to maintain lending.”

Although the FPC “advised” UK banks to build up capital, supervisors are being blunter in private. The FSA can veto bank bonus plans if it believes that the pay-outs are hindering efforts to build up capital.

The Basel Committee on Banking Supervision has given banks until 2019 to amass top quality “core tier one capital” equal to 7 per cent of their assets, adjusted for risk. The biggest banks will also be slapped with an additional surcharge of 1 to 2.5 per cent to protect them from damaging future losses.

The US Federal Reserve, as part of its stress testing process, has effectively limited dividends at large banks to 30 per cent or less of anticipated earnings in 2011, the FPC minutes said.

UK regulators decided against similar numeric guidance because they felt that banks in a strong capital position should not be constrained by moves aimed at their weaker peers, according to the FPC minutes. The FPC also feared that a strict limit could either prompt banks to grow their balance sheets too quickly or raise banks’ cost of capital at a time when they need to build up their stores.

The public message about retaining earnings to amass capital is intended to give management cover in the face of investor pressure to return cash.

The FSA can “help overcome the collective action problem by making sure that they are all simultaneously thinking about the need to retain capital in good years so that there is this buffer that they can keep on the path to Basel III, even in bad years,” Lord Turner, FSA chairman, said.

Industry groups warned against piling conflicting demands on banks. “As at least some banks become more utility-like, there will be an investor expectation of a steady flow of dividends which cuts across the FPC’s exhortation that banks should build capital,” said Simon Hills of the BBA.

And Michael Lever, a managing director at the Association for Financial Markets in Europe, warned that “uncertainty over the cumulative effect of the extensive regulatory agenda on economic growth...risks seriously impairing the ability of banks to flexibly manage their capital positions.”

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