U.K. banks, under pressure from the Bank of England to increase capital, may do exactly what the central bank doesn’t want them to do: Cut lending.
While trimming or delaying dividends, selling assets, reducing pay or raising equity would also bolster capital, banks such as government-owned Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc may be tempted to shrink lending, said Paul Mumford, who helps manage about 350 million pounds ($569 million) including Barclays Plc, RBS and Lloyds shares at Cavendish Asset Management Ltd. in London.
“I’m not sure how they will get the capital, but one of the ways is lending less money,” Mumford said. “You can’t encourage banks to lend more and tighten up on the other end of the scale.”
Britain’s four-biggest banks may need as much as 60 billion pounds in extra capital to meet future loan losses, compensate customers and pay regulatory fines, according to the Bank of England’s Financial Stability Report last month. Central bank Governor Mervyn King is pressing banks to raise capital levels without reducing lending to support an economy struggling to avoid a triple-dip recession.
“If you tell banks that they need to raise capital, they may try to preserve that capital position by not lending,” Vivek Raja, an analyst at Oriel Securities Ltd. in London. The Bank of England is “at odds” with this view because it said banks need clean balance sheets before they can provide new loans, Raja said.
Lloyds, the U.K.’s largest lender to families and small businesses, pared back lending in the third quarter by 2.77 billion pounds, according to the Bank of England’s Funding for Lending Scheme data.
The program, which started on Aug. 1, allows banks to borrow U.K. treasury bills to help lower the cost of loans for small businesses and home-buyers. The plan was designed to boost credit by at least 80 billion pounds and revive growth, it said at the time.
While Barclays helped British banks to increase lending by 496 million pounds in the three months to Sept. 30, Santander U.K. Plc and RBS cut back.
Reducing lending “doesn’t increase the pounds amount of capital, it increases the capital ratio,” said Ian Gordon, a London-based analyst at Investec Plc. “That’s precisely what the Bank of England has allegedly said isn’t acceptable, but it’s what I expect to be delivered.”
Chancellor of the Exchequer George Osborne is urging banks to lend more to stimulate growth after Britain’s economy emerged from recession in the third quarter. The U.K. risks entering its first triple-dip recession since records began 60 years ago, a Bloomberg News survey of economists said last month.
“Credit is the lifeblood of the economy,” said Vicky Redwood, chief U.K. economist at Capital Economics Ltd. in London. “Firms have retained profit to spend and households have their income, but many spending and investment decisions hinge on being able to borrow from banks.”
The central bank in November said it had asked the U.K.’s Financial Services Authority to review whether banks have adequate capital. Capital ratios may be overstated by as much as 35 billion pounds, it said. A further 10 billion pounds may be needed to cover the repayment of customers wrongly sold products and an additional 15 billion pounds for extra provisions on bad loans.
The Bank of England’s “recommendation is designed to strengthen resilience in the banking sector and, by tackling balance sheet problems, increase its ability to support new lending to households and businesses,” said a spokesman for the central bank in a statement. “There are a number of possible actions banks can take to strengthen resilience in ways that do not hinder lending to the real economy.”
The push to enhance the financial strength of banks comes as lenders prepare for tougher capital rules under Basel III. U.K. lawmakers in the Parliamentary Commission on Banking Standards today also pressed for the government to have greater powers to break up banks should they fail to comply with proposals to build firebreaks around their consumer operations.
Shrinking the balance sheet, “is precisely what is continuing to occur,” said Investec’s Gordon. “You only need to look at the funding for lending figures.”
Lloyds and RBS have the most capital to raise because of their higher ownership of “difficult” assets such as commercial real estate in Ireland, Morgan Stanley analysts including Chris Manners wrote in a Dec. 17 note to investors.
Manners estimates the FSA will find banks need 26 billion pounds of capital in its so-called base case, with the shortfall ranging from 11 billion pounds to 93 billion pounds. RBS may need 7.87 billion pounds, Lloyds 6.51 billion pounds, HSBC Holdings Plc 6.39 billion pounds and Barclays 5.55 billion pounds, he wrote.
HSBC declined to comment beyond its Nov. 5 earnings statement, which said it generated $2.8 billion of capital in the quarter. Lloyds declined to comment beyond its Nov. 1 results, which said “we have a strong capital position and are confident that we will meet future regulatory capital requirements.”
A spokesman for Barclays declined to comment beyond Finance Director Chris Lucas’s comments on Oct. 31 when he said that the bank’s “capital and liquidity remains strong.”
A spokeswoman for RBS declined to comment.
“The U.K.’s banks are well capitalized and positioned for the transition to Basel III,” the British Bankers’ Association said in a statement. “But, as the Bank of England’s Financial Stability Review noted, they are operating in a challenging and uncertain environment.”
The FTSE 350 Banks Index declined 0.5 percent in London trading today. The measure of Britain’s biggest bank stocks has risen 35 percent this year.
One option to raise capital could be to follow the example of Barclays, which last month issued $3 billion of 7.625 percent subordinated 10-year notes, which will be written down to zero if the U.K.’s second-largest lender has losses that reduce its core Tier 1 equity ratio to 7 percent or lower.
The Bank of England Financial Stability Report in November suggested banks could issue such contingent capital instruments.
“The fact Mervyn King and the financial stability board have thrown their weight behind it suggests Lloyds and RBS will issue some Co-Cos,” said Cormac Leech, an analyst at Liberum Capital in London. “The nice thing about Co-Cos is they would mean treasury wouldn’t have to stump up more cash and it would avoid equity dilution” for the U.K.’s part-nationalized lenders, he said.
Banks may also try to sell assets to bolster capital. Lloyds could sell half its insurance business, including Clerical Medical and Scottish Widows, Leech said. The bank plans to raise about 1 billion pounds by selling its stake in U.K. wealth manager St. James’s Place Plc, the Sunday Times reported on Nov. 4.
U.K. Financial Investments Ltd., the steward of the government’s 81 percent stake in RBS in October said it had written to the bank to suggest the lender sell its U.S. unit, Citizens Financial Group Inc., to increase shareholder returns. RBS Chief Executive Officer Stephen Hester in November said it’s a core part of the bank.
Banks may have to cut the price of assets to achieve sales. RBS will probably have to accept a lower offer for 316 branches it has to sell after Santander abandoned a 1.7 billion-pound offer for them, a person with knowledge of the matter said last month.
Barclays and RBS may need the most capital because of their potential bill for litigation related to the manipulation of the London interbank offered rate, Leech said.
Barclays was fined 290 million pounds by regulators in June for manipulating Libor, the benchmark for more than $300 trillion of contracts from mortgages to interest-rate swaps.
U.K. lenders may also have to add to a total of about 11 billion pounds set aside already to compensate clients who were forced to buy, or didn’t know they had bought insurance to cover their repayments on mortgages, credit cards and other loans.
The central bank hasn’t specified a deadline for banks to increase capital. The timing may be determined by Mark Carney, who succeeds King in July.
“You can understand Mervyn King wanting to make a parting shot, making sure that the momentum for stronger capitalization and regulation isn’t lost in the handover” to Carney, said Simon Willis, an analyst at Daniel Stewart Securities Plc in London. “It will take some time to make clear what Carney’s views are.”