Are Britain’s banks strong enough for coronavirus?
Recently the share prices of the UK’s largest banks have collapsed, in common with those of many other companies.
Banks such as RBS, Barclays and HSBC have seen their share price fall to levels not seen since the 2008 financial crisis.
Some market-watchers suspect the sellers know something we don’t, but others suggest the banks are in fact much stronger compared with 12 years ago.
The Bank of England has said the banks should be strong enough to weather a 30% contraction in the UK economy.
But someone who would have liked the banks to have been stronger entering the crisis is Sir John Vickers, the man who was charged with constructing a safety plan for Britain’s banks in the wake of the financial crisis.
“The global effort to reform the banks after the crisis of 2008 did a number of good things but I generally think of it as a job half done,” he told the BBC.
Sir John has spoken out before on the topic after recommending banks have considerably more capital.
Capital is the amount by which a firm’s assets exceeds its liabilities – such as its customer deposits. When liabilities are higher, the company is technically insolvent. For banks, it’s important capital is available to absorb surprise losses from bad loans. The more a bank has, the more punishment it can withstand without outside help.
Banks periodically tell investors how much capital they have, when they report profit and other figures, but critics say it’s not an up-to-date measure.
Some, including Durham University Professor Kevin Dowd and former Bank of England regulator Dean Buckner, say the most appropriate capital measure is a market value one, which is based on banks’ share prices.
This is calculated by multiplying the number of shares in issue by the current share price. They prefer this measure because share prices are an up-to-date reflection of what investors think a company is worth, whereas the banks’ reported figures are not.
In a report earlier this month, the pair suggest that using the banks’ market prices on 1 May, every £100 of bank assets, such as loans, is supported by an average of just £2.73 of capital among the UK’s five largest banks.
That means that if investors’ valuations of the banks are correct, and should the value of all the assets drop by more than 2.73%, the banks would require help from investors or government, or face bankruptcy.
Prof Dowd and Dr Buckner calculate that this measure, known as the capital ratio, was £4.70 per £100 as recently as December and £11.20 in 2006, before the crisis.
For some investors, however, the share price is not a reliable guide.
Jamie Ward, a fund manager at CRUX Asset Management, says bank shares are cheap and lenders are much safer than they were. He looks at total loans compared to capital, but prefers to use the bank’s measure rather than share prices.
He also looks at a measure the banks favour, which applies so-called risk weights to the loans a bank makes, which produces a bigger ratio. Credit card loans are thought to be less risky than mortgages, for instance. Using this measure, banks’ capital ratios have swelled from 4.5% to about 14.8%.
“The capital in the banking system now is multiples of the level it was in 2008,” he says. Banks have shrunk since the crisis and changed their tune on risk and growth, he says. “They look like completely different businesses.”
His fund holds shares in three UK banks, and has grown by about 85% since March 2011.
The extra capital UK banks have raised since the crisis has come from selling shares and bonds and through keeping profits in reserve. They’ve raised more than £130bn, the Bank of England has said.
So how come the dive in share prices? “Scars from 2008 are deep and painful and very visible,” he says.
After the collapses and bailouts of that era, investors have been skittish about investing in bank stocks, and as they panic, share prices will plunge. And with a long period of convalescence with no dividends paid to shareholders, they have been easy to ignore and drop.
“We’ve had 10 to 12 years where investors have been rewarded for ignoring a sector that hurt them in 2008,” Mr Ward said. He said he doesn’t think they need any extra capital after the Bank of England’s stripped-down coronavirus stress test suggested they should survive.
But Sir John warns against relying on accounting measures of capital when bank share prices are low. “Look at both,” he says. “Don’t assume that banks are stronger than market values suggest”.
He adds that adjusting asset values by looking at risk isn’t “useless” as some critics claim, but it is backward-looking and may not help you when a crisis arrives, like coronavirus.
“But we are where we are”, he says, “and the important thing is to stop further capital leakage by way of dividends and other payouts”. He welcomed the Bank of England’s banning of the banks from paying dividends but was surprised it didn’t happen sooner.
Stephen Jones, chief executive of UK Finance, the trade association for banks, said for the banking system,”for the last 10-12 years the increase in loss absorbing capital has been massive”.
“Is everything going to be fine? We don’t know,” he said, but the Bank of England’s modelling suggests “the system as a whole is solid”.
“The banks aren’t the problem in this crisis, the impact of the pandemic on the wider economy is the problem.”
He defended the risk weighting system, saying it is “an international system policed by the Basel committee and based on international banking standards”, overseen by the Bank of England in the UK.
In many ways the state has already moved to prop up the banks.
In March, interest rates were cut to new lows and the Bank of England agreed to buy £200bn of bonds, helping lower borrowing costs. The government is guaranteeing billions of pounds of loans to businesses through the Coronavirus Business Interruption Loan Scheme and the Bounce Back Loan Scheme.
But this is more debt that will eventually have to be repaid.
For Sir John, more capital could have put an end to these arguments.
“The complexity of all this is just mindboggling and if banks were properly capitalised we wouldn’t have to talk about all of this in such technical terms,” he says.
He says precisely how much capital they should have is a vexed question, but suggests each pound of share capital should support no more than £12-15 of loans – a ratio of about 7-8%.
“In calmer times, we could have had a bigger capital buffer built at almost no cost to the economy – virtually free insurance,” he says. “And if we had done that we would have been in better shape going into the crisis.
“I am not predicting it’s all going to collapse but there are greater risks than there needed to be.”