Capital Shortfall of £25bn Identified at UK Banks

UK banks have a capital shortfall of £25bn and must close the gap by the end of this year, according to Bank of England (BoE) policymakers. The BoE added that the banks had been underestimating the amount of capital they needed by around £50bnand must make a more “honest” assessment of hidden losses on their balance sheets.

The assessment follows an estimate by the BoE’s financial policy committee (FPC) last November that the shortfall was within the region of £24bn to £60bn. Regulator the Financial Services Authority (FSA) undertook an analysis of the amount of capital banks were holding against three areas:

  • Leniency to customers in arrears, aka ‘forbearance’.
  • The potential future bill for compensation claims for mis-selling products such as payment protection insurance (PPI).
  • The way international capital rules allow them to make judgments about the riskiness of loans, known as risk-weighted assets (RWA).

The FPC made maximum estimates of those three factors for the four major banks at up to £15bn, £10bn and £35bn respectively, giving a cumulative total of £60bn but a lower-end estimate of £24bn. The UK’s two part-nationalised lenders Royal Bank of Scotland (RBS) and Lloyds Banking Group are believed to account for much of the shortfalls.

The FSA’s review began at the end of November after the last quarterly FPC meeting when the members of the committee, chaired by the BoE’s outgoing governor Sir Mervyn King, had expressed concern about whether banks were making “honest” assessments of the amount of capital they hold.

The review represents one of the watchdog’s final acts. As of 1 April, the FSA will be broken up and replaced by two new bodies. The Financial Conduct Authority (FCA) will assess the way firms behave and the Prudential Regulation Authority (PRA) inside the BoE will take over assessment of the amount of capital banks have.

The FPC announcement followed a joint statement issued by the FSA and the BoE outlining measures to make it easier for new lenders to enter the UK banking sector and compete with the ‘Big Four’ of RBS, Lloyds, Barclays and HSBC. New banks will be required to hold 4.5% in equity capital against assets, around half the levels required of the Big Four and the minimum necessary to meet the capital adequacy requirements of Basel III.

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