Why Britain Is So Concerned About Its Big Banks
Regulators in the U.K. are getting ready to rewrite their banking laws in a way that makes the Dodd Frank financial reform law in the U.S. seem tame by comparison. On Monday, the U.K.’s Independent Commission on Banking is scheduled to make preliminary recommendations for new regulations.
If Britain retains any vestige of its former imperial self, it may be its banking system. British global banking giants such as Barclays extend far beyond the U.K.’s relatively modest contemporary borders, and have a powerful presence in markets around the world. When Lehman Brothers failed in 2008, it was Barclays that bought its core U.S. investment banking business.
Yet far from being a matter of national pride, those big U.K. banks are a target of anger and concern. Thanks to the financial crisis, the British banks and London’s hedge funds faced a powerful crackdown on compensation. And now regulators in the U.K. are getting ready to rewrite their banking laws in a way that makes the Dodd Frank financial reform law in the U.S. seem tame by comparison.
On Monday, the U.K.’s Independent Commission on Banking is scheduled to make preliminary recommendations for new regulations. One likely outcome would force banks to create separate subsidiaries for deposit taking operations and its trading and investment banking units. While the businesses could remain within a single holding company, they would have their own balance sheets, forcing the banks to raise billions of dollars in additional capital, which would reduce profits, according to Chip MacDonald, a partner with global law firm Jones Day.
While the Dodd-Frank law has largely forced banks in the U.S. give up trading for their own account, the implementation of that law is far from complete, and big U.S. banks can retain the bulk of their investment banking businesses.
The reason for the U.K.’s determination to bring its banks to heel has a lot to do with market structure. “The banking business in the U.K. is much more concentrated than it is in the U.S.,” MacDonald says. In the U.K., a handful of banks including Lloyds, Barclays, Royal Bank of Scotland and HSBC control around 90 percent of market share. Lloyds alone has 25 percent of the retail deposit market, according to MacDonald.
And those banks required a massive public intervention. Northern Rock was taken over by the government, as was Bradford & Bingley. The government owns 84 percent of RBS and 42 percent of Lloyds, according to MacDonald.
In the U.S., banks are limited to 10 percent market share, and even large lenders such as JPMorgan Chase still have room to grow. “The British are more worried about banking competition, the moral hazards of bank bailouts, and the systemic risks of banks that are too big to fail,” McDonald says. While those concerns are legitimate, he says current proposals for reregulation could drive capital out of the country, which would hurt job growth and the economy.
Barclays has talked about the possibility of relocating its headquarters to New York, a scenario that MacDonald says is plausible if the latest ideas about regulation are put into law.
One proposal would require deposit-taking banks to obtain all of their funding from government Treasuries. That would cut so deeply into profits that the loan-making part of the banking business would be compromised, according to MacDonald. “The British have to be very careful and very thoughtful about how they approach bank regulation, to avoid creating a different set of problems,” he says.
Already, there are indications that bank profits in the U.K. — and throughout Europe — are falling, due to tough interpretation of Basel III rules that will force institutions there to raise more capital than their counterparts in the U.S. Deutsche Bank said April 4 that it has lowered first quarter estimates or two thirds of the European banks that it covers. It expects return on equity in the low teens for the group, which has given up shareholder gains for 2011 and is now flat.
Deutsche Bank expects Barclays to generate a return on core tangible equity of 11.2 percent this year, 12.5 percent next year and 13.2 percent in 2013.
While that is up slightly from the nadir of the financial crisis, it is nowhere near the ROTE levels of the 2006 and 2007 period, when they hit the low 30 percent range. Essentially, the ROTE levels aren’t expected to recover from crisis levels any time soon.
Meanwhile in the U.S., the Bank of America is targeting 15 percent and JPMorgan is targeting 17 percent.
Bank profits in the U.K. are bound to take a hit as regulators attack every last excess in the system. Whether that makes banking any more stable — or helps the economy — remains to be seen.