Capital Law May Cut Bank Profitability to 11%, McKinsey Says

(Updates with BBA comment in fifth paragraph.)

Aug. 31 (Bloomberg) -- Lenders may struggle to earn more than an 11 percent return on their equity as they implement rules and capital requirements costing $610 billion over the next seven years, according to a report from McKinsey & Co.

Global regulations, including the mandatory clearing of over-the-counter derivatives and higher capital requirements, may force banks to pass on a “portion of the higher regulatory costs” to customers, the study said. Banks should “conserve capital and boost efficiency” to stay profitable, London-based McKinsey said.

“After mitigation, average returns-on-equity across businesses will likely be 11 to 12 percent but with considerable variation,” according to the report, written by a McKinsey team led by Philipp Haerle and Thomas Poppensieker in Munich. “Some of the worst-hit businesses with ROEs below the cost of capital may have to be disposed of, especially at banks with weak franchises.”

European lenders will need to raise an extra 423 billion euros ($611 billion) by 2019 to comply with global capital rules approved by the Basel Committee on Banking Supervision, according to a European Union study. The Basel committee also said last month that 28 banks would be subject to additional capital requirements to rein in too-big-to-fail banks.

The McKinsey report “is driven by Basel III,” Irving Henry, a director at the London-based British Bankers’ Association, said in a telephone interview today. “The fact is that change is coming.”

Counterattack

McKinsey said that “increased counterparty-credit-risk charges” as well as “liquidity and funding requirements” will hurt bank profits along with increased capital requirements.

Global banks started a counterattack against the capital guidelines last week, warning the rules may reduce lending and harm growth.

The Clearing House Association and the Institute of International Bankers, whose members include JPMorgan Chase & Co, Bank of America Corp., and Deutsche Bank AG, said in a letter that capital surcharges are “deeply flawed” and “reflexively based on the notion that size alone creates prudential concerns.”

--Editors: Anthony Aarons, Heather Smith

To contact the reporter on this story: Ben Moshinsky in London at bmoshinsky@bloomberg.net;

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net.