The various misgivings the wider market has about the UK’s banks are well-rehearsed but so – through articles such as Sneaking up and Robust Bank Story – is The Value Perspective’s belief those misgivings are overstated. That being the case, you may not be surprised to find us pointing you towards the latest Financial Stability Report, which was published last month by the Bank of England.
Of all the potential concerns relating to the banks, four tend to be raised most often by investors – uncertainties over the regulatory framework ; the prospect of further fines for misconduct; the outlook for emerging markets (primarily with regard to HSBC and Standard Chartered); and capital adequacy levels. So let’s take a look at what the Bank of England has to say about each of these in turn.
On the subject of regulation, the Financial Stability Report notes how, since the financial crisis, “authorities have worked to establish standards for bank equity and other capacity to absorb losses in order to fix some of the major fault lines that caused the financial crisis. The work to design those standards is reaching completion and is now moving into the phase of full implementation.”
Over the last eight or so years, the wider market has been inclined to view banking regulation as a football pitch where the goalposts – at the times they were even visible – were constantly on the move. In this report, however, the Bank of England has come out and said the rules are what they are and, as such, investors should now feel a lot more comfortable about where they stand.
Another big concern relates to the huge fines racked up by the sector for a dispiriting array of bad behaviour since the financial crisis. According to the Bank of England, between 2009 and 2014, UK banks had to pay out some £30bn in fines while setting aside a further £13bn in case of others – and, of course, it is the prospect of what might be unearthed in the years to come that really worries the market.
We would make a couple of points here – the first of which is that it is not as if the authorities have been giving the banks an easy run. On the contrary, the fines meted out for misselling payment protection insurance and other misconduct, all of which were wholly unknowable risks eight years ago, have been very painful – and yet the banks are still here.
What is more, the most recent round of regulatory stress-tests involved scenarios where the banks were fined a further £40bn and even in that unlikely scenario – after all, the sanctions so far are surely more likely to have encouraged an improvement in behaviour, ethics and corporate culture rather than any deterioration – the sector was not expected to need to raise further capital.
It is a similar story with regard to emerging markets, where the banks have been stress-tested for some very bleak scenarios, including a severe downturn in China and the associated negative consequences for commodity prices and global stockmarkets. Even if this were to happen though, the regulator does not expect the banks would need to raise any more equity.
To be clear, we are not suggesting the emerging markets are no longer a risk but they are not a wholly unknown risk. And the regulator, which has complete access to all the banks’ books and loans, has stress-tested for a very negative outcome and expects even HSBC and Standard Chartered, which have by far the most emerging market exposure, would survive without further injections of capital.
That brings us neatly to the final and most important of the four considerations – capital levels. For eight years now, the wider market has fretted that banks do not have enough capital and that, because they are ‘black boxes’, it is impossible really to know what is going on. And yet the whole point of the stress-tests and new regulation is to open up any metaphorical boxes that might exist to full scrutiny.
Disclosure by UK banks has arguably never been better and the regulator, which as we said has full access, has now concluded “the aggregate Tier 1 capital position of major UK banks was 13% of risk-weighted assets in September 2015 [in line with the regulatory requirements], even though some elements of the requirements have yet to be phased in. And banks expect to build their equity ratios further in coming years.”
Clearly it is important not to become too carried away here. When thinking about potential future risks, then – whether it be regulators with their stress-tests or investors with their portfolio exposures – it is human nature to ‘fight past wars’. Yet the risks of tomorrow are always going to be different beasts from the crises of yesterday – that, after all, is what makes them risks.
While one should thus be careful about reading too much into its specific monetary and percentage outcomes, the Bank of England’s report clearly suggests the concerns traditionally voiced about UK banks are overstated. Coming as it does from an organisation that has spent the last eight years trying to de-risk the sector, the report is arguably as close to a clean bill of health as we are likely to see.