Hostile government
Indeed, the government's banking levy – which came into force on 1 January and aims to raise £2.5bn a year – is a particular thorn in the sector's side. It also represents a surprising approach for the Conservatives, who have traditionally been perceived as City-friendly. Certainly, there may be a moral case for a levy after the banks received so much state support – the problem is that it has been introduced into the UK unilaterally, potentially leaving major foreign financial centres with an advantage. Moreover, Chancellor George Osborne announced in the Budget that the levy would be increased to offset any gains the banks would make from the corporation tax cut. That was described as "surprising" by Matthew Barling, tax partner at PricewaterhouseCoopers "given the government's objectives of enhancing the competitiveness of the UK tax system and for the City of London to remain a world-leading financial centre."
The levy, especially, worries the banks. Standard Chartered's chief executive, Peter Sands – using the levy as an example – pointed out that "rather than seeing increasing global coordination and consistency of regulation, we are seeing fragmentation and unilateral action." He warns of "unintended consequences". HSBC's chairman, Douglas Flint, meanwhile, hinted that a move overseas could even be on the cards. The levy, he said "constitutes an additional cost of basing a growing multinational banking group in the UK".
Then there's the Independent Banking Commission (IBC). The government established the IBC under the chairmanship of the former boss of the Office of Fair Trading, Sir John Vickers. The aim, among other things, is to consider whether banks should split their retail banking operations from their investment banking businesses. That's potentially bad news for the likes of Barclays, Standard Chartered and HSBC – all of which boast substantial investment banking businesses.
The interim report is due on 11 April, with the final report due in September but, already, Sir John has said that one way to tackle concerns associated with universal banking is to "ring-fence the retail banking activities of systemically-important institutions and require them to be capitalised on a stand-alone basis". That's not gone down well in the sector: "it will mean different regulation for different parts of the same business – it's very strange and will distort the financing of the UK economy," says Angela Knight, chief executive of the British Bankers' Association (BBA).
Then there are bankers' bonuses. In December, rules came into force requiring 40-60 per cent of the variable pay of bank executives to be deferred for three to five years, and at least 50 per cent of variable pay to be in shares. And the government's project Merlin proposals include scrutiny requirements on bonuses. While it may be morally undesirable for bankers – who had to turn to the government for support during the financial crisis – to receive huge bonuses, overzealousness here is leading to an exodus of talent from established centres, such as London, to Asia.
| The government: "We need to strike a balance" |
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Bankers may be worried about the competitive threats faced by such measures as the banking levy and the IBC's eventual findings, but Mark Hoban – Conservative MP for Fareham and the Financial Secretary to the Treasury – adopted a more sanguine tone when discussing those concerns. "It was necessary to strike a balance," reflects Mr Hoban regarding concerns that the levy might push some banks to leave the UK. "We worked very hard and in a consultative way but, ultimately, it's necessary to form a judgement to ensue that they [the banks] pay an appropriate amount to reflect the risks their operations pose to the UK's economy." He doesn't readily accept that rules on bankers' bonuses are entirely to blame for the growth in the number of bankers relocating overseas, either – especially to Asia. "There are a number of different factors at work," he says – including the growth of Asian markets. "Bonuses needed to be aligned with the interest of shareholders." And, while he won't be drawn on the competitive impact of the possible findings of the IBC – ahead of those findings being released – he's clear about the importance of the commission's work. "It's very important given the size of the banking sector and its impact on the UK economy that we consider how to make it more stable and safer." The IBC's focus on competition is a factor, too: "There has been a significant reduction in competition, especially after the HBOS merger." Although tackling that by encouraging new entrants, who face significant regulation-driven barriers to entry, doesn't sound like a top priority; he focuses on the need for a more efficient banking market and greater product competition. "A new entrant can only prosper if it can take market share, otherwise why invest the capital? They need a market they can actually get stuck into." Mr Hoban wasn't able to elaborate much on the government's approach to selling its shares in RBS and Lloyds – other than to reiterate the government's commitment to eventually doing so. "We haven't set out a timetable; we do want the taxpayer to get their money back." But he was rather clearer, however, about the need to dismember the FSA and dismisses suggestions that this involves little more than a disruptive deckchair-moving exercise. "The [regulatory] architecture put in place by the previous government was flawed," he insists. "No one was really tasked with looking at financial stability." |
More regulation
Quite apart from the disruption faced by the sector as the government sets about dismembering the Financial Services Authority (FSA), a long list of new rules are also set to make life tougher for the banks. The FSA's approach to implementation of the new Basel III rules is proving a particular concern.
Basel III requires banks to hold core tier one capital that's equivalent to 4.5 per cent of their risk-weighted assets, plus an additional 2.5 per cent buffer – giving a 7 per cent minimum ratio. Full implementation isn't required until 2019, and most UK banks – unlike many in Europe – already appear sufficiently well capitalised to meet the new criteria. Yet the UK is likely to require banks to hold rather more than the 7 per cent minimum – like Switzerland, a 9-10 per cent ratio is being mooted. That could even force some – Barclays has been mentioned – to raise more capital. The problem is that holding more capital is costly – it limits funds for lending and means lower returns.
Liquidity rules are an issue, too. Basel III sets a net stable funding ratio – this requires banks to match the duration of their assets more closely to their liabilities. It includes a shorter-term liquidity coverage ratio, to ensure banks hold enough liquid assets to cope with sudden high levels of depositor withdrawals. The timetable envisages these requirements taking effect from 2015 but, at the start of the year the FSA began implementing them unilaterally. Specifically, banks will be required to deposit funds with the Bank of England and the regulator is taking a tougher line on the definition of liquid assets than is demanded by Basel – essentially limiting this to low-yielding cash and sovereign debt.
The rules have sparked a debate about the impact on global economic growth as banks are forced to horde capital and invest in low-yielding liquid assets. The regulators, predictably, don't sound worried. The Basel Committee issued a report in December claiming that there would be a "maximum decline in the level of [global] GDP, relative to baseline forecasts, of 0.22 per cent" if the requirements are implemented over eight years. But that doesn't factor in the liquidity rules, or the fact that some regulatory regimes – such as the UK's FSA – are set to introduce much tougher rules than the minimum and much quicker.
| The industry: "Investors need confidence too" |
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The financial services industry employs over 1m people in the UK and generates about 10 per cent of the UK's GDP, compared with 3.8 per cent in Germany. Measures that could undermine the competitiveness of UK banks, then, look like bad news for UK plc. It's a worry that Angela Knight, chief executive of the British Bankers' Association, is focused on. As Ms Knight reflects on the government-driven and regulatory challenges facing the sector she talks of uncertainty. "There is a whole series of unknowns," she says. "The links are not necessarily being made to the impact on the economy." Some think those challenges could even force banks to relocate. Careful to point out that no bank has threatened this – some merely have location as an issue to consider – she says that the City already faces natural competitive threats from faster-growth economies. These are largely Asian economies, but she expects the US to return to decent growth, too. Here in Europe, however, it's a different matter. "European growth will be much lower – Europe always defaults to more regulation." Her question, then, given the highly mobile nature of banking, is: "Are we doing enough to keep what we have?" On that she's cautious: "We need high quality, but also a level playing field; we want the equivalent implementation of standards." But a level playing field looks absent. "We are already superequivalent on Basel III," she insists. "The liquidity requirement, too – we did it early." She's particularly concerned about extra liquidity criteria: "It's potentially bad for the economy as it means banks hold billions in forms that then can't be lent." The government's banking levy is another issue. "Once you scramble the egg you can't unscramble it," comments Ms Knight on the potentially irreversible damage that the levy could do if it's not implemented carefully. "It taxes operations outside of the UK – that just doesn't look right to us." There's also the IBC's eventual line on possibly splitting investment banking from investment banking – an approach that looks similar to that adopted by the long since repealed Glass-Steagall Act in the US. "Glass-Steagall type thinking has been ditched by every country," she points out. "If the UK then operates a radically different model then it [the UK] will be a very strange place to do business." The ICB is also looking at competition in the banking sector. "Forced sales, split-ups – what about investors?" asks Ms Knight. "Investors need confidence, too." |
The economic threat
Perhaps the biggest unknown facing the UK's banks is the economy. As the graph (below) shows, bank share prices are notably correlated with economic growth. That's hardly surprising – in a period of economic growth, demand for credit rises and defaults are minimal. When the economy stumbles, bad debts soar and demand for credit evaporates. That leaves banks facing losses as provisions against bad debts rise and falling earnings as new lending disappears. That the UK's economy should recover, then, is a prerequisite for a healthy banking sector.
Certainly, bad debts have fallen fast in the past year as the economic recovery – shaky though it is – got under way. But the government's determination to cut public spending deeply and quickly casts doubts over the sustainability of that recovery. If the economy stumbles, unemployment – already at a 17-year high – could rise further. Higher unemployment and faltering economic growth worsening as interest rates inevitably rise is bad news for banks – it potentially means more bad debt provisions as hard-pressed borrowers default and it spells trouble for loan growth and, therefore, earnings growth. In short, a return to business as usual for the UK lenders is nowhere on the horizon.
Banks v GDP
