Basel Blogging

The Basel committee recently moved to clarify the new banking capital adequacy requirements and, as expected is raising regulatory ratios. It is of course debatable that such a move provides a cast iron guarantee against further crises but it is fair to say that banks that retain better quality capital are likely to be more resilient in future periods of crises.


Whatever the reactions of the weaker (and stronger) banks to these requirements, the new world will make new demands of shareholders, regulators and governments alike. More bank capital means there will less for others to share around. Banks will have to increase their core tier-one capital ratio to 4.5% by 2015.. In addition, they will have to carry a further "counter-cyclical" capital conservation buffer of 2.5% by 2019. Any bank that fails to meet the new requirements is expected to be banned from paying dividends to shareholders. Understanding the real risk inherent in a bank’s assets will be crucial in making an assessment of the bank’s value. Balance sheets will be more important than ever before. Whilst most UK banks have already exceeded the 7 per cent for Tier 1 capital (and shares have rallied) this isn’t true across the board and has yet to be adhered to by many multi-national financial institutions.

Of course this will affect banks’ appetite for engaging in all types of business, not least mortgage lending but as for the real impact upon individual markets and activities we will have to wait. Fair to say residential mortgage lending is not about to take off.

Will these measures be enough? I suspect so as a considerable amount of time has been granted by policy-makers to banks to put these measures into place. However only recently Lord Myners suggested that the global deal on banks’ capital was ‘disappointing’. and did not push the financial institutions hard enough to become safer..

Having said that, I don’t think anybody wants to wipe out the banks ability to finance an economic recovery. But be under no illusions these measures will hurt and will remind banks they are under more scrutiny than ever before. This story is set to run…

Confidence tricks

Everywhere you look confidence is an issue. The recent Nationwide Consumer Confidence Index reflects that consumer confidence continued to fall during July. Economic news from the Bank of England suggests we will charter “choppy waters” for the coming 12 to 18 months. But perhaps the real figures of note behind yesterday’s revisions to growth and inflation (and indeed future consumer sentiment) are the unemployment figures. While unemployment fell 3,800, the number taking part-time jobs rocketed 115,000 to a record 7.84 million and the number of long-term unemployed grew. Furthermore wages slipped further behind the cost of living.

Unemployment (or fear of it) really matters because while the fear of what is coming can already be seen through the consumer confidence survey, the impact of these cuts has yet to be felt. Will the private sector be in a position to take up the slack created by the slaying of public sector excess? This is the single biggest factor that will determine not only the success of the coalition but also banks’ appetite for lending.

Whether in mortgages or business loans the banks remain nervous. The holding strategy recently announced of setting up a committee to examine the lack of small business lending sums up the banks current attitude. If we are really going to get liquidity back then banking and investor confidence remains key. They not only have to see a future but believe it is attainable. This is a waiting game but also a catch twenty two. Again confidence is the key.

What is certain is that as soon as one moves, the others will.

The Elephant in the Room or ‘has anyone seen my prop?’

So where do we go next?

The analogy I’ve started using is the one about the building that had subsidence and was propped up with Acrow props. For building read the banks and financial system and for Acrow props read Special Liquidity Scheme (SLS), Credit Guarantee Scheme (CGS) and Quantitive Easing among others.

The trouble is that these ‘props’ start to be removed next year and the Bank of England is adamant that they won’t be replaced. But I’m afraid that it doesn’t stop there. According to the Bank of England Financial Stability Report published in June, there is a total of £165bn of repayments due under the SLS and £120bn of guarantees under the CGS by the end of 2012. These are the props of course. In addition, by the end of 2012, the Bank of England forecast around £480bn of unsecured senior debt, subordinated debt, covered bonds and securitisations maturing or callable over the period. That’s an eye watering £765bn for the market to find by the end of 2012 which equates to an average of £25bn a month. With the debt crisis in Greece we have nowhere near achieved this year to date. The building is looking a little shaky at this point!

The Bank is clearly well focussed on this but has also made it very clear that they expect the industry to find this money themselves and that there will be no further Government or Bank of England bail-outs. So can they? Frankly I doubt it. If they can’t and there’s no assistance then have no doubts, with the props taken away the system will crash again.

Banks globally have continued to de-leverage since the onset of the credit crisis and in the UK this has meant that banks have assets of around 19 times their capital rather than the 30 times we saw at the end of 2008. This has manifested itself in declining asset classes including not only those esoteric types of asset, the derivative, but also in the tangible loans made to other banks, corporates and individuals. This is one of the reasons that Vince Cable has been urging banks to lend more. The banks are saying they are lending as much the market currently demands. This may or may not be true in the SME sector, I’m not an expert, but it doesn’t sound right to me in relation to mortgages. Residential mortgage loans represent the largest single asset class in the UK at around £1.2tn. It is mind-blowingly massive. To fund this, banks and building societies are having to use retail deposits and wholesale markets. Although retail deposits are growing overall they are simply not sufficient in scale to meet the problem. As competition hots up in this sector, they will become less useful as a funding mechanism due to increased expense and volatility as they change hands between deposit takers more rapidly. Not only that, mortgages are inherently medium to long-term assets and funding them solely from demand to one year maturity deposits simply doesn’t work if you want a stable market. Ask any Treasurer. If you are still in doubt about the over-reliance on short term debt to fund longer term assets then look at Northern Rock and remember the queues. The Bank of England recognises this and is exhorting banks and building societies to lengthen maturities of funding saying that an increasing reliance on short-term funding is undesirable and would perpetuate the structural fragilities in funding profiles that have caused disruption in the last three years (so we agree on this). The stability the Bank of England is looking for can only be achieved by issuing term maturity debt instruments and in particular Covered Bonds and Mortgage Backed Securities.  

Building Societies get a special mention where some £22bn of maturing fixed rate bonds will need refinancing in 2010. With highly competitive retail deposit markets building societies will have to either cut back further on lending activities or look to other sources of funding such as pooled securitisation ideas and strengthening core Tier I capital. Looking at Kent Reliance and their deal with JC Flowers we can see they have already gone down this route. Further consolidation in this sector looks inevitable from where I’m standing. Amazingly, the Bank of England is suggesting that the relevant provisions of the Building Societies (Funding) and Mutual (Transfers) Act 2007 are implemented to eradicate the preferential status that wholesale lenders achieve when lending to Building Societies.  In other words they want banks lending to Building Societies to carry more risk than at present so as to encourage them to take a more rigorous approach to assessing risk and controls over the Building Society sector. Isn’t that what the FSA should be doing rather then getting banks to do it? My fear is that this will just make it much harder for Building Societies to borrow from banks and hasten their sector’s demise.

So the banking reporting season is under way and the results by and large seem positive and encouraging. Sadly I’m not so sanguine. It seems to me that we have a massive elephant in the room that no one is talking about. I don’t think the banks and building societies can refinance £750bn through the markets alone and if they can’t then without Government support the market and the economy has a very big problem.  Slowing of lending activity will slam the brakes on recovery. If the props are removed too soon then the whole edifice is in danger of falling down!

Where's the cunning plan?

Well I failed to get a blog out in July, a month which saw the FSA launch their CP 10/16 Responsible Lending paper. My excuse was that I was on holiday at the time and when I was faced with trying to download a 186 page document onto a Blackberry in Portugal whilst sipping a glass of Vinho Verde I gave up.

I did see the industry response however, most of it hostile to the FSA.

I’m back now and have read it and have been able to consider my feelings.

In short there is nothing of any great surprise in the document so to that extent I don’t think the industry response was proportionate, as the FSA would say. Would I rather we didn’t have another slew of regulation to assimilate? Of course I would and so to that extent it doesn’t make me feel any better because it just isn’t going to help get the mortgage market back on its feet.

The problems the industry are facing have nothing to do with irresponsible lenders , borrowers or bad practices, regardless of how much of that actually went on, but a Global credit crisis and ensuing liquidity shortage which has not gone away. So to that extent the potential changes to regulation don’t make things worse at a macro level – they just give us a number of additional things we need to focus on. More importantly it doesn’t make it any better either.

Is this the FSA’s fault? Short answer has to be no!

So where does it leave us and where next for regulation?

What I think is missing from a policy perspective is what is the overall vision and strategy for the UK? What level of home ownership does David Cameron see as being the desirable for the UK going forward and is it consistent with the ‘aspirational views’ broadcast by his housing minister Grant Shapps? And do we really expect to have a vibrant market with masses of products, innovation and lenders to choose from? If we do then CP10/16 does little to further that aim given that its focus is on stable markets not supply and innovation. At some point I would love to see a clearly annunciated strategy and vision which the multipartite authorities are able to frame their policies and proposals around. We wouldn’t expect a company to operate without an overall strategic plan and business plan would we? Why should the economy be any different?

A step into the unknown

George Osborne’s bank levy to raise £8.3billion in four years rightly made budget headlines last week. Part political opportunism, part economic necessity, this measure was met with broad public approval. After all, no-one is going to begrudge the Chancellor his swipe at the banking sector whose stock among the public both literally and figuratively is at an all time low. What’s more this move will meet with international approval as politicians across the globe implement schemes like this to recoup losses and make a point.


This figure at first sight appears considerable but in the context of likely bonus payouts by the banks over the same period I suspect will be manageable. More worrying may be its impact on their capital bases. With wholesale funding remaining tight the levy must be accurately judged so as not to undo the repair to balance sheets that is currently underway. And while the banks will benefit from cuts in corporation tax too this levy must not make operating in the UK unattractive compared to other jurisdictions given its reliance on Financial Services.

The expectation of many is that banks such as Lloyds, RBS, Barclays and HSBC will shoulder the lion’s share, the very banks that are (with Santander) exclusively writing the UK’s current mortgage business. With access to wholesale money still difficult demands on capital remain acute. How they choose to accommodate the levy may have consequences for their lending activity. The levy is a political and economic gamble which will exact a modicum of revenge for the excesses of the past but we must hope not at the cost of future mortgage lending.

Death by a thousand cuts?

The budget promises death by a thousand cuts but if it’s light on detail at the end of June then more will come in the spending review. This is even more likely following the announcement by Fitch, one of the world’s biggest credit rating agencies, warning that the Government must cut spending by some £86bn, equivalent to the entire NHS budget, over the next five years to maintain Britain’s reputation with international investors. Fiscal policy sends signals to markets and citizens alike about a Government’s intent and will tell us how fast and how profoundly we are willing to tackle the deficit. In this case the Government must act decisively and quickly to avoid the danger of falling into a double dip recession and to ensure that World opinion of the UK remains positive.

As mortgage practitioners, we are all reading the runes to determine when the market will get back to something resembling normality. While fiscal measures will affect confidence, in the form of likely job security – specifically in the public but also the private sector – wages and the abolition of certain public service projects, monetary policy is equally important to the long term health of the home-owning market.

Interest rates have been on hold at record lows for many months now, effectively putting money back into the pocket of borrowers on SVR or tracker rates. Should wage inflation kick in then interest rates will go up and the pain for thousands of borrowers will become more acute. Of course a burst of remortgage activity may be no bad thing but remember that many borrowers on interest only mortgages may not be in a position to find a like for like affordable deal. Indeed more and more lenders are turning away from interest only mortgage deals with some encouragement from the FSA and any remortgage is likely to be locking a higher margin for the lender than the product that it replaces. We have already seen, over the last couple of years how supply has not been able to meet demand. Total number of mortgage products available in the markets is today less than 15% of the number that were available in the peak of the markets and there are none for the credit impaired market. Interest rates have never been a subtle tool as they treat the UK as a homogenous economic unit when in fact what it feels like in London is not how it may feel in Nottingham. Nevertheless, millions would be affected by a rise in interest rates and so whatever fiscal measures are adopted, monetary policy will still play its part.

small advisors beware!

Only last week, an ex colleague approached me for advice. A relative who runs a small Directly Authorised firm had been given thirty days by the FSA to stop trading, hire a Compliance Director, or find a home as an Appointed Representative of a network. Without being privy to the facts of this particular case, it is my guess that he is not alone. You might not like it but you could understand if the FSA privately regards small DA’s as inconvenient and costly to regulate. This poses the bigger question, why would you want to be Directly Authorised in the current mortgage market?

When mortgage regulation arrived almost ten years ago, many suggested up to 20% of a DA’s time would be redirected into regulated matters, at a substantial loss of turnover, and the time to process any sale would increase owing to paper work. That is a stretch for any small business. Throw in subsequent initiatives from regulators, networks and lenders alike (TCF,MMR,RDR, I could go on)and you can quickly see how being a small DA might feel like running through treacle.

As a result of more sophisticated means of monitoring, many DA’s, who may once have considered themselves too small to bother the FSA, now enjoy even greater vigilance and policing from the regulator. Lost time, increasing regulatory fees, and falling mortgage and insurance income will present small DA’s with a strategic decision. My advice is to make the choice before it is forced upon you.