Monday, 24 September 2018

Capital offence

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The public disagreement between Antony Jenkins and the Bank of England over cutting lending has its roots in the Prudential Regulation Authority’s own dithering over bank capital.

Jenkins, who for the past year has affected a mild-mannered, very un-Bob Diamond-like demeanour, announced last Friday that Barclays might have to cut lending to meet the PRA’s newly imposed 3% leverage target by the end of the year.

This in turn was met by a chorus of political bluster about not being held to ransom by the big banks, and a warning from the Bank of England that a capital-raising plan that relied on cutting lending would not be acceptable.

But Jenkins’ reaction was entirely sensible. Indeed, he would have been within his rights to publicly protest that his bank was being punished for being one of the few that has lived up to its undertaking to increase lending in support of the UK’s economy.

The PRA has not sprung the 3% leverage ratio out of nowhere – it was always supposed to come in by 2018, giving banks time to meet it through retained earnings (or squeezing comp).

It is also true that it is wise to introduce a simple leverage ratio (in addition to a capital requirement based on risk-weighted assets), given the justified scepticism about banks’ RWA calculations.

But with little warning, the PRA has massively accelerated the timetable – now it is apparently vital to ensure banks are compliant by the end of 2013.

Martin Taylor, formerly of Barclays himself but now on the Bank of England’s Financial Policy Committee, told the UK parliament’s Treasury Select Committee that it should not be “taken in” by claims from the banks that the leverage ratio was a surprise. But it is hard to read it any other way.

Every public pronouncement suggested the leverage ratio was on track for 2018. Every part of UK bank behaviour suggests that these institutions were blind-sided by the demand to raise common equity by the end of the year.

Barclays, calculating its own leverage ratio in the April 2013 interim management statement, came up with 20 times. The PRA found an extra 20 turns when it did the numbers, possibly by counting derivatives exposures differently. Apart from providing an illustration of just how complex coming up with objective ratios can be, this does not suggest an institution that knew what was coming.

To make matters worse, Jenkins cannot even turn to sub debt to fill the gap. The EBA has specified technical standards for what Additional Tier 1 is in the brave new world – how to write it down, how to write it up, how to make sure it absorbs losses. It has done this in full knowledge of the failure of pre-crisis hybrids, and explicitly intended to design loss-absorbing instruments.

The PRA has to accept these rules. Indeed, the UK, with possibly the largest and most experienced regulatory establishment in Europe, has been instrumental in preparing them.

But what is the point if it then decides the new instruments will not count as capital for purposes of the leverage ratio calculation – opting to factor in only equity, rather than all Tier 1 capital, instead?

Additional Tier 1, under the new rules, is specifically a creature of risk-weighted regimes. The trigger it must have is at 5.125% of risk-weighted assets. But the writedown it will experience once triggered is real – and just as valid in a leverage ratio as a risk-based capital regime.

The distinction between risk-based and pure leverage ratio is about the asset side of the balance sheet, not the liabilities. It is hard to see why there should be any distinction between the definition of going concern loss-absorbing capital between the two regimes.

The PRA evidently thinks otherwise, so Barclays cannot issue hybrids to meet its “urgent” leverage ratio target. That means raising equity (while trading at 70% of book value) or shrinking assets. Jenkins, caught in a trap not of his making, is thus forced to threaten to reduce lending.

So who screwed up? Regulators are blaming Barclays, which did too little too late. Barclays, mindful of a tense political environment, is blaming nobody. The regulatory machinery has been changing rapidly, with architects of the old regime such as Paul Tucker departing the Bank of England, and vastly enhanced regulatory powers for the Bank following the dissolution of the FSA.

Mistakes do happen in such environments. Barclays may have taken a cue from one end of the regulatory machinery that more gone-concern loss absorption was needed – which would explain its decision to issue Tier 2 CoCos in November and April – and that the leverage ratio could wait – only to have that direction countermanded from on high.

Or regulators might have a grudge against Barclays. It is, after all, the poster bank for the Libor scandal, proud defier of state assistance and defender of universal banking. The increasingly powerful Parliamentary Commission on Banking Standards could also have encouraged the PRA to act early.

Its first report, in December, said that the Financial Policy Committee should have the duty of setting the leverage ratio from spring 2013, and that it expected the leverage ratio to be set significantly higher than the 3% minimum required under Basel III. It was an odd comment for a backbench committee to make to a supposedly independent central bank, but it may have been influential nevertheless.

In any case, the Bank and the PRA ought to know better. Politics should not trump the logic of a consistent capital regime sensibly applied, especially if doing so makes it even harder and more expensive for banks to lend – and risks hindering a weakened economy even more.


When a block trade fails there is no shortage of rival bankers, investors, commentators – and senior managers at the firm involved – primed to hurl abuse at the foolish individuals willing to gamble for the sake of the league tables.

Yet the harm done to the broader market is tiny. The stock typically recovers within a fortnight, even if the bank is left holding some of the shares. There are bruised egos and some losses, to be sure, but overall the damage is minuscule.

A failed IPO, on the other hand, ripples through the new issue market and across country borders.

It’s easy to blame market conditions and a seller unwilling to move on valuation when cancelling an IPO – as leads did on last week’s failed Deutsche Annington float of up to €1bn. But shouldn’t a group of nine banks (plus an adviser) have a better read of the market, not to mention greater influence on the seller?

In fact, one head of ECM involved in the deal claimed just ahead of bookbuilding that the seller, Terra Firma, was proving very flexible on pricing of the real estate company.

Things change, of course. No one could have predicted that within a few hours after bookbuilding began on June 19, Ben Bernanke would bring markets crashing down. But the leads still had two weeks to adjust the transaction.

As soon as the market dropped, feedback turned negative on valuation. The last-minute attempt to rescue the deal by cutting the number of shares but not the valuation – taking the free-float to just 16.3% – seemed unlikely to succeed. And it didn’t.

A yield story being unsettled by expectations of rising rates is no great surprise. But the failure to adapt to circumstances shows the new issue market in Europe – however much it has responded to the post-mortems of failed IPOs in 2011 and 2012 – still needs to become more nimble.

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