U.K. banks’ business models risk becoming “unsustainable,” discouraging investors as tougher regulations reduce lenders’ return on equity, according to the Association of British Insurers.
Regulators’ commitment to reducing leverage, increasing banks’ capital reserves and imposing new rules to prevent a repeat of the 2008 financial crisis may deter equity investments in banks, the London-based ABI, which represents investors with 1.8 trillion pounds ($2.9 trillion) of assets, said today in a report.
“Lack of clarity regarding capital levels, and the apparent conflict between resilience and recovery, are muddying the investment case for U.K. banks,” the ABI said. “Banks must be correctly capitalized but not over-capitalized.”
The four biggest British banks may be overstating their capital positions by as much as 35 billion pounds, Bank of England Governor Mervyn King said last week as he asked the Financial Services Authority to review whether banks have adequate reserves. The largest U.K.-based banks, HSBC Holdings Plc (HSBA), Royal Bank of Scotland Group Plc, Barclays Plc (BARC) and Lloyds Banking Group Plc (LLOY), may need to make bigger provisions for future loan losses, according to the central bank.
Banks’ return on equity, a measure of profitability, must exceed their cost of equity, otherwise they will be “unsustainable in the longer term and will inevitably constrain asset growth and lending to the wider economy,” according to the ABI report.
The cost of equity for consumer banks is about 8 to 10 percent, while about 15 percent for investment banks, the ABI estimated. Global banks’ return on equity was 5.1 percent in 2011, according to McKinsey & Co., a New York-based management consultant.
Regulatory “clarity” on whether the U.K. will impose stricter rules on its banks than other countries and a lack of certainty over future capital requirements are putting off investors, the ABI said.
The U.K. government is implementing the Independent Commission on Banking’s recommendation to partially separate consumer and investment banking. The panel, led by Oxford University academic John Vickers, proposed large banks should have “loss-absorbing capacity,” including equity, of 17 percent to 20 percent of risk-weighted assets. The remainder could be held as so-called bail-in bonds, which can take a loss when a bank fails and may be converted into equity, according to the 2011 ICB report.
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