WEEKLY COMMENT 10-12-2015
By Barry Edwards
The Bank of England (BofE) published their stress test report on the large UK banks which found that all of them were adequately capitalised for conditions in the current financial climate. Most large banks around the world have gone through a substantial recapitalisation process after the financial crisis and their financial stability is now mainly considered fit for purpose by the central banks that are responsible for their activities.
The EU set out to establish a bank recovery and resolution procedure, for all 28 countries, to cope with any bank failure in the future which is nearly complete and becomes operational on January the 1st 2016. PwC has prepared a good summary of the directive which explains the purpose and intentions. Also the BofE has issued their financial stability report which explains their views on capital adequacy and the possible problems that could challenge UK banks. If you click on the links below you can read both reports;
http://www.bankofengland.co.uk/financialstability/Documents/fpc/fspapers/fs_paper35.pdf (The Introduction 3 pages, full report 25 pages)
Bank stability and their capability of providing the funds to support lending requirements for business and private individuals has been a subject which is being discussed all the time. Many economists and politicians believe that the banks do not fulfil this aim and need to be more accommodating to get the economy growing at a higher rate to fully recover from the crisis. Around the world there is a problem with banks willing to lend to SME’s and great efforts are being made to improve this blockage.
Some people still believe that despite all the recapitalisation and regulation to prevent another crisis occurring, banks are not adequately capitalised and controlled to be certain of managing a serious recession in the future. The reasons for this are centred on the way banks operate and function which these people maintain is not fit for the modern digital age.
On capitalisation, the Financial Stability Board (FSB), which is an international group making recommendations for all countries about all things financial has stated that the level of capital should be around 16-19% of risk weighted assets (RWA). The BofE is suggesting that 12-14% is adequate for the UK at the moment with the condition that if lending becomes more risky, they can require further capital injection to support the balance sheet. The new powers given to the BofE do provide for active involvement in various classes of lending to control risk. All developed economies have now implemented regulations to take similar action. Some commentators believe large banks should maintain a capital to RWA level of 20%.
Most discussion about how banks operate is concentrated around financial technology usually referred to these days as ‘Fintech’. Payment systems and security to protect customers from fraud dominate the media as hackers and criminals become ever more efficient at accessing the computer networks. Innovation is moving forward at such a pace that banking will be very different in 10 years’ time with much more competition from companies not currently active in financial services. We have already seen competition in the SME sector and large retailers are offering banking services in many cases discounted if you buy from them.
The bread and butter services banks have traditionally provided are gradually being offered by non-financial businesses reducing the main source of revenue that they have relied upon. These large businesses have built up enormous cash balances which they have deposited with banks, with interest rates so low they are now starting to provide lending facilities and/or vendor finance to customers to improve the returns they can obtain.
Banking is changing so rapidly and the traditional ways they have made profits are being challenged all the time. Banks are going to have to reinvent themselves if they are going to survive, at the moment no one is quite sure what that new business model will be. The new regulations mainly apply only to the banks and new technology is available to everybody with the resources to compete with them. The difference between the banks and the non-financial businesses is that they do not gear up the lending against the capital they have which makes them eminently much safer for the economy as a whole.
The Vickers report which advised the separation of investment and personal banking has been adopted and has been scheduled to become effective in 2019 which will concentrate banking activity further. The banks will become providers of corporate finance and investment services while the personal banking side is likely to develop in conjunction with retailers and payment system providers to administer everyone’s day to day financial requirements. Financial stability in the banking system should become more certain as the changes are adopted and the bailing out by tax payers should become a thing of the past.
That’s all for this week, more observations next week.