BOE Says U.K. Banks Have a Capital Shortfall of $38 Billion; Banks need to set aside more money to cover bigger potential losses on commercial real estate and from the euro area, possible fines for mis-selling and stricter risk models

BOE Says U.K. Banks Have a Capital Shortfall of $38 Billion

By Ben Moshinsky and Jennifer Ryan – Mar 27, 2013

U.K. lenders were told by the Bank of England to raise 25 billion pounds ($38 billion) of additional capital, less than analyst estimates.

Banks need to set aside more money to cover bigger potential losses on commercial real estate and from the euro area, possible fines for mis-selling and stricter risk models, the Bank of England said following a report by the Financial Services Authority. The BOE didn’t identify or quantify the number of lenders that need to bolster capital and it said plans already announced by banks should cover about half the shortage.

“It’s a bit of a damp squib,” said Simon Maughan, an analyst at Olivetree Securities Ltd. in London. “The banks are going to have until the end of 2013, at least, to do it and there was no change to the message that they won’t need to raise fresh capital or restrict dividend payments.”

The BOE is pushing banks to increase resilience so they can boost lending and fund an economic recovery. The bank’s focus on loan losses could still hit Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc (LLOY) the most because of their commercial real-estate holdings, while Barclays Plc (BARC), with its investment banking unit, would be most affected by the changes to risk weights, Maughan said. RBS and Lloyds have announced asset sales this year to bolster capital, and Barclays plans to sell contingent convertible notes.

Loan Losses

The FTSE 350 Banks Index (F3BANK) (F3BANK) was little changed as of 11:52 a.m. in London. Lloyds, the country’s largest mortgage lender, was up 2 percent, while Barclays advanced 0.2 percent. RBS, Britain’s biggest publicly owned lender, slipped 1 percent.

The BOE said that expected loan losses could exceed provisions by 30 billion pounds, while future fines and conduct- related penalties could be 10 billion pounds more than banks expect. It said lenders underestimated assets weighted for risk by 170 billion pounds, leading to a 12 billion-pound capital shortfall in that category.

The full impact of the three areas could deplete lenders’ capital by 52 billion pounds, less than the 60 billion-pound estimate that emerged from the BOE’s November Financial Stability Report. Some banks already have enough resources to cover them, paring the shortfall to 25 billion pounds, the BOE said today.

“The actions that banks need to take depend on whether, and if so how far, their adjusted capital falls short of the level the FPC judges banks need to ensure sufficient capacity to absorb losses and sustain lending in the current juncture,” the BOE said in the statement.

‘Manageable’

BOE Governor Mervyn King said the shortfall “is not an immediate threat to the banking system and the problem is perfectly manageable.” He also said the recommendations won’t require additional government investment in banks.

Lenders will have to reach a common equity tier 1 capital ratio of 7 percent of risk-weighted assets by the end of 2013. While some banks already exceed this level, those that don’t will have to boost capital or restructure their balance sheets without hindering lending to the economy, the BOE said.

“It’s a relatively low bar,” said Cormac Leech, a banking analyst at Liberum Capital Ltd. in London. “They’re saying that the banks will continue to build capital to comply with that metric, so it doesn’t sound like there’s a massive pressure on the banks to exceed Basel III requirements.”

‘Clear Plan’

HSBC Holdings Plc (HSBA) and Standard Chartered Plc (STAN), the two British banks that get most of their profit from Asia, have the strongest core Tier 1 capital ratios under Basel III at 9.8 percent and 10.7 percent respectively. Barclays has a ratio of 8.2 percent, Lloyds 8.1 percent and RBS 7.7 percent.

Officials at HSBC, Lloyds and RBS declined to comment. Barclays said in a statement today it has a “clear plan” to reach its capital target by 2015.

Since the BOE asked the FSA in November to examine capital levels, banks have announced asset sales and other plans to bolster balance sheets. Lloyds sold a stake in asset manager St. James’s Place Plc, booking a 400 million-pound gain, while RBS said last month it will sell its U.S. operation and shrink its securities unit.

“We know what the plans of the banks are,” BOE Deputy Governor Andrew Bailey said, adding that about half the shortfall should be covered in those proposals. “We are not saying that those plans are absolutely baked in, and have been given a seal of approval. They will be scrutinized.”

The Prudential Regulation Authority, which will take over from the FSA next month, will assess banks’ capital adequacy. It may impose higher requirements on lenders with “concentrated exposures to vulnerable assets, where there are uncertainties about assets not covered in the FSA’s assessment of future expected losses or risk weights analysis or where banks are highly leveraged relating to trading activities,” the BOE said.

The BOE also said the PRA should ensure banks have “credible” plans to reach the Basel III targets in 2019. It also called on the authority to develop a plan for stress- testing U.K. banks.

To contact the reporters on this story: Ben Moshinsky in Brussels at bmoshinsky@bloomberg.net; Jennifer Ryan in London atjryan13@bloomberg.net