Uncertainty shrouds Barclays

Banking giant Barclays has revealed uninspiring trading for the first quarter of 2011. Reflecting what management describes as a "subdued macroeconomic environment", total income fell 8 per cent on 2010's first quarter. Also this month, Barclays revealed that it would take a £1bn hit to cover compensation payments for mis-selling so-called payment protection insurance (PPI). That's the second-largest charge among UK banks; only , which provided £3.2bn, was hit harder.

But with mounting regulatory pressures, Barclays' problems don't stop there. It has already been hit with the government's banking levy - that cost Barclays £100m in the first quarter of 2011. But, more significant, is the approach of the Independent Commission on Banking (ICB) to tackle the risks that investment banking operations may pose to banks' retail operations. True, the ICB's interim report last month rejected a total separation of retail and investment banking. But it does favour ring-fencing investment banking within separate subsidiaries, while bulking up capital requirements. Barclays has a big investment bank - it generated nearly 60 per cent of the group's first-quarter pre-tax profit - so a tough line could be costly. Moreover, it's possible that the ICB's final report, due in September, might be tougher than the interim report.

Then there's the need to provide more capital against risks, led by the implementation of the Basel III capital adequacy rules. True, Barclays looks well capitalised. Under old rules, at the end of March, its tier-one capital (basically, equity) was 11 per cent of risk-weighted assets. It may not look so good under the new rules. It's widely anticipated that the UK's bank regulators will impose a minimum capital requirement that exceeds the Basel III's minimum ratio of 7 per cent - possibly 10 per cent. And some City analysts think Barclays is the least well-placed among the UK banks to cope with such demands. Broker Evolution Securities expects Barclays to face a £2bn capital deficit by 2013, suggesting that a fund-raising could even be needed.

Still, Barclays coped well during the financial crisis. Unlike Lloyds and Royal Bank of Scotland, it did not need a bailout from the state. That allowed it to remain in private hands, which means it can pay dividends. But the way in which it kept itself afloat during that difficult time - including raising capital by selling its asset management arm - has left a structural issue. Barclays is now largely dependent upon UK-focused retail banking and investment banking, which both have their problems.

Take retail banking. While the UK's economic recovery was under way during 2010, Barclays' recession-induced bad debts began falling and, with its first-quarter update, management reported that the group impairment charge had dropped 39 per cent year on year to £921m. But with government austerity measures yet to really bite, the improvement may not be maintained. To begin with, much-reduced public spending could yet derail the UK's fragile economic recovery and undermine demand for loans. Simultaneously, higher unemployment, as public sector workers lose their jobs, could mean rising bad debts.

Meanwhile, Barclays' large investment banking arm, Barclays Capital, could struggle to compensate. After all, investment banking profits are volatile. Barclays' investment banking profits for the first quarter of 2011 slumped 29 per cent year on year on the back of lower contributions from the fixed-income business. With most of the bank's profits being generated from such an unpredictable business - and given the challenges still facing the retail side - City analysts are sceptical that Barclays can meet its aim of achieving a 15 per cent return on tangible net assets by 2013. "[The target] should be seen in our view as an absolute blue-sky scenario," say analysts at Evolution Securities. "We do not think it is achievable."