FSA tries to ease banks’ capital burden
Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Amid the blizzard of measures unveiled by the UK government and financial regulators this week, one of the least-noticed might turn out to be among the most significant in easing the pressure on Britain’s banking sector.
Bank executives on Tuesday hailed the Financial Services Authority’s statement on bank capital as a clear signal that the regulator is seeking to ease the strains on banks’ balance sheets caused by the credit crunch and subsequent economic crisis.
However, it remains to be seen whether investors and credit ratings agencies will follow the FSA in allowing banks to reduce their capital ratios significantly during the coming economic downturn.
The credit crunch has blown holes in the balance sheets of many large banks, forcing them to raise fresh capital from a variety of sources including sovereign wealth funds, shareholders and – most recently – the government. Now banks are facing concerns about mounting losses on loans to consumers and businesses as a result of the recession.
When Britain recapitalised its banking sector last October, the aim was to remove any remaining doubt about whether lenders had sufficient capital to absorb these losses.
Since then, however, banks have faced two constraints. The first is uncertainty about the appropriate level of capital they will be required to hold in future. The second is a fear that, as the recession deepens, international banking regulations enshrined in the Basel framework will force them to set aside an ever-increasing amount of capital against existing loans. These factors have prompted banks to hoard capital.
The FSA is attempting to address both issues. The regulator says now that, at the low point of the cycle, it expects banks to have tier one capital reserves worth about 6-7 per cent of assets, adjusted for their riskiness.
At the same time, the FSA is tweaking the complex models that banks use to calculate the riskiness of their loan portfolios. In recent years, it has pushed banks to measure the probability of a loan defaulting based on the most recent available data. In a recession, however, this approach could force banks to set aside more capital for the same loans – a phenomenon known by regulators as procyclicality.
On Monday, the FSA signalled it would allow banks to start measuring the probability of a loan defaulting using an average calculated over the course of the economic cycle. It is likely to be the first step in moves by the FSA and other regulators to draw up new banking regulations that force banks to set aside greater reserves in good times.
By allowing banks to adjust their capital models, banks could be spared an increase in capital demands of as much as 20 per cent during the coming year. Patricia Jackson, head of the prudential advisory practice at Ernst&Young, said the new approach was “excellent”. “Dealing with the procyclicality of the Basel accord is of critical importance to regulators and central banks,” she said.
But the approach is not without its critics. Some investors say the FSA’s decision will merely add to suspicions that banks are using questionable calculations to hide bad loans. But officials argue it would be a mistake to focus blindly on a single mathematical ratio. “When it comes to quantifying the capital requirement, no part of it is easy, and no part of it is judgment-free,” says one.
It is also far from clear that banks will ultimately accept the offer to reduce their capital ratios. “It will be a brave bank chief executive who tells his supervisor he plans to run the bank with lower capital ratios, and a brave supervisor who agrees,” says John Tattersall, a partner in the financial services regulatory practice at PricewaterhouseCoopers.
The other question facing bank executives is whether investors will accept the FSA’s measures of capital strength. In the past, banks have tended to hold greater capital reserves than the minimum required by regulators in order to protect precious credit ratings. More recently, stock market investors have tended to concentrate on banks’ reserves of equity capital, as this will be first to absorb any losses the institution might suffer.
Nevertheless the FSA, and the banks it regulates, will be hoping that international regulators follow its lead and that a global shift in the measurement of bank capital will be too powerful for investors to ignore. “If you get all the major banking regulators in the world saying this is the new measure, that will have an influence,” says one UK banking executive. “The proof will be determined over time.”
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Short sellers keep low profile after ban is lifted
Short sellers did not pile on bets that the shares of banks would fall when the ban on the practice was lifted last Friday, according to early data, in spite of warnings sounded by some politicians and the Archbishop of York, writes James Mackintosh.
Figures from Data Explorers show there was only a small rise in the shorting of Barclays on Friday, a day when the bank’s shares fell almost 25 per cent.
According to Data Explorers, the borrowing of stock in the country’s main banks and insurers was little changed, suggesting short sellers, who borrow then sell shares in the hope they can buy them back more cheaply, did not rush to take advantage of the lifting of the rules.
There is almost no borrowing of stock in Royal Bank of Scotland, the struggling bank now 70 per cent owned by the government.
Many hedge funds have been reluctant to put on significant trades long or short after heavy losses, and the industry as a whole is sitting on close to record amounts of cash, analysts say.
The lack of trading in bank shares has also made it hard to put on a big short position quickly, managers said.
There have been few disclosures of big new positions since Friday under rules introduced last year requiring the publishing of details of shorts of more than 0.25 per cent of a financial company.
Lansdowne Partners, one of London’s best-known hedge funds, said it was now short 0.26 per cent, or £21m ($29m), of Barclays and 0.32 per cent, or £27m, of Prudential.
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