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If UK banks are hoping for a post-Brexit smooth ride from regulators on capital buffers, they must face a shock, if not early disappointment.
At first, second and third glance, the UK’s proposals to implement the latest package of global bank capital standards clash with the government’s pledge to make the City of London a more favorable location for financial services after EU divorce.
The Bank of England, even by its own account, is going for stricter enforcement of the rules than the EU. Authorities in the bloc are considering several deviations from new global standards that the EU risks material non-compliance, according to its top regulators.
UK bank executives and their lobbyists largely disagree with the BoE’s assertion that a stricter approach will help them, claiming that value investors hold to higher standards. Bankers argue that investors will be more concerned about the increased costs and lower returns that go hand in hand with what they see as gold-plated standards in the EU.
Some of the finer details of the BoE’s proposals have also attracted sharp criticism from bankers who question how they fit with high-profile promises from politicians such as Chancellor Jeremy Hunt to turbocharge City growth with reforms.
One area of controversy is how banks should treat small business loans. In its efforts to make capital requirements more sensitive to risks in the property market, the BoE is proposing changes to global rules that would effectively make small business loans backed by commercial property more expensive for banks than equivalent firms backed by any collateral.
“That’s what we’re most worried about,” says a senior executive at a UK lender, describing the move as “completely illogical” and “really, really damaging” given the high percentage of loans to small and medium enterprises. Secured on property. .
The UK’s approach to corporate loans is also attracting scrutiny. The package of global standards – known as Basel 3.1 by regulators and Basel 4 by virtually everyone – imposes new rules on lending to businesses that do not have a credit rating, a category in which most UK and EU corporates fall. To determine what capital buffer a bank needs, regulators require banks to estimate their assets after adjusting for risk—multiplying by a percentage factor that takes into account the potential for loss.
The UK proposal gives banks a choice. They can apply 100 percent risk weighting on all their loans to unrated corporates, in line with global norms. Alternatively, they can apply a 65 percent risk charge on loans to high-quality unrated corporates and a 135 percent risk charge on loans to low-quality ones. UK bankers say this will put them at a disadvantage to EU banks, which will benefit from a more lenient regime, at least for the transition period.
It could lead to a fragmentation of the UK market which would ultimately hurt borrowers. Bankers say lenders have to choose a better method for high quality loans (65 and 135 percent options) or low quality (100 percent emphasis on everything). They say that choice will change market dynamics.
A bank that chose a 100 percent risk-weighted regime would find it difficult to compete for high quality loans with a lender that chose a regulatory option with lower charges for such loans, resulting in less competition in UK corporate lending. Other difficulties surround areas such as mortgage valuation and trade finance, where the BoE has chosen a more conservative treatment than the EU.
A senior executive at another major UK lender says the proposed changes could give EU competitors a “material advantage” in individual products. The banker argues that UK banks will then move away from those sectors, even if they have sufficient capital overall, because banks look at products individually.
But the saga is not over yet. The BoE has launched a four-month consultation on its proposals and a senior banker says it is more open than previous proposals. Banks are preparing data on the potential unintended consequences of the proposals, which the BoE appears keen to receive and review. Executives say they are reasonably optimistic about resolving issues “around the edges”, but fall short of bringing the UK to a position that is closer to the EU.
Their success, or otherwise, will test the other big promise of the UK’s post-Brexit regulatory approach – more “agile” and responsive decision-making than in the EU.
laura.noonan@ft.com
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