epa03436716 A pedestrian walks by a Virgin Money branch in London, Britain, 17 October 2012. It has been reported that Sir Richard Branson wants to buy 316 branches from Royal Bank of Scotland. The entrepreneur of Virgin Money has had informal contact with RBS about a possible purchase after the deal to sell the branches to Bank Santander collapsed last Friday.  EPA/FACUNDO ARRIZABALAGA

The Bank of England has issued a warning about the sort of risky lending practices particularly important to Virgin Money, at a critical time in the bank’s negotiations over a £1.6bn takeover by rival CYBG.

In a letter sent to bank chiefs last week seen by the FT, the Prudential Regulation Authority, BoE’s supervisor of the largest banks and insurers, said “a small number of firms” were vulnerable to sudden losses if customers on zero per cent interest credit card offers then leave earlier or borrow less than expected.

Melanie Beaman, PRA director for UK deposit takers, wrote that banks with high reliance on so-called “effective interest rate” accounting should consider holding additional capital to mitigate the risks.

The letter did not explicitly name Virgin Money but the bank is widely seen by analysts to be the most exposed after aggressively expanding its credit card business in recent years.

Almost 20 per cent of Virgin Money’s annual net interest income in 2017 came from the EIR method. Industry executives said any perceived threat to capital levels could strengthen CYBG’s hand in negotiations.

Virgin Money declined to comment on the PRA’s letter or the merger discussions. CYBG and the PRA also declined to comment.

EIR allows lenders that offer products with temporary interest-free periods to book in advance some of the revenues they expect to receive once the introductory period ends.

Optimistic assumptions about factors such as customer retention rates and future borrowing levels allow banks to report higher incomes, but increase the risk of valuation errors that could lead to a reversal and weaken their balance sheets, according to the PRA.

The Bank of England began raising concern about interest-free offers last year, prompting leaders at several major banks to criticise the practice.

However, Jayne-Anne Gadhia, chief executive of Virgin Money, has repeatedly defended her company’s approach. In a call with analysts last month, Ms Gadhia said the bank was “seeing good performance” from the first 4,000 customers to come off their promotional periods, and a person close to the bank said this week that its assumptions about customer behaviour had continued to hold up since.

The PRA promised to carry out a review of EIR accounting across the industry earlier this year. The latest letter, which was dated June 6, said it had found “a number of factors . . . that warrant further supervisory monitoring”.

The letter was sent three days after Virgin received an improved takeover approach from CYBG, the owner of Clydesdale and Yorkshire banks.

CYBG has until next Monday to make a formal offer for Virgin, with the two banks’ boards currently in discussions to reach an agreement. A combination with CYBG — which has only a small credit card business — would reduce the relative exposure of Virgin’s balance sheet to credit card risks. Virgin estimates revenues over a seven-year card life; changing the models to use a five-year period would have hit its revenues by £25m last year.

Letter in response to this article:

Call me old-fashioned but EIR is accounting nonsense / From David Riviere, Haywards Heath, W Sussex, UK

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