UK banks will fail legal capital requirement needs and risk assessments if recommendations from the ICB report are implemented too soon, say analysts.
“The fact that banks have been given until 2019 to implement reform highlights that change can’t happen until losses on bad loans have all been crystallised,” says James Ferguson, head of strategy at Arbuthnot Securities.
“The deadline of 2019 is a thin disguise to the fact that right now no banks will pass. If they were to push through losses, banks would be shown to be insolvent. If banks were forced to implement reforms in a shorter time frame, they would fail.”
The proposals – dubbed the Vickers report, after ICB chairman Sir John Vickers – was released on September 12 and recommends that banks separate their retail banking sector from riskier investment banking operations.
The report also recommends a doubling of capital requirements of at least 10% for smaller banks and a safety cushion of between 17% and 20% of assets in the largest banks.
The ICB suggests that reforms are implemented by 2019, but if the Commission suggests a shorter deadline, banks will not be able to cope, say analysts.
“Banks need to have sufficient capital in the first place to run down as losses are absorbed in a downturn,” states Ferguson. “Banks carried insufficient capital before the crisis, so a regulatory requirement to build capital up before losses have been processed would exacerbate the credit crunch.”
Although time is necessary for banks to successfully create sufficient capital and implement ring-fencing, extended time given to banks means that changes to banking reform will continue.
“In the next four years, there may be a different government in power that could introduce changes,” says Joshua Raymond, chief market strategist at City Index. “Moreover, banks have strong lobbying groups which may pressure for changes to reform.”
Since the release of the report, market participants have voiced concerns over potential and unintentional consequences after implementation. One of the main issues that experts point out is that the financial system could face increased systemic risk, as an interest in the shadow banking sector could become a “go-to” area again.
“Banks may stay quiet for a year or so to come, but eventually they may begin putting pressure on the government to relax reforms in their favour,” says Lothar Mentel, chief investment officer at Octopus Investments. “The debate will reopen and lobby groups will want to see if they can limit the severity of the reforms. The ring-fence model will only work if there is better quality supervision of banks to regulate and monitor their actions.
“If regulation [of reforms and the financial sector] is understaffed, underqualified and underfunded, financial institutions will be able to side step rules put in place by the ring-fence. Supervision of banks and, more importantly, of the shadow banking sector of structured credit markets needs to be beefed up.”
Conversely, more market turbulence could create scope for further changes to recommendations in banking reform.
“That might mean stricter measures to the current ring-fencing model that has been suggested,” says Raymond.
But the probability of a crisis on the scale seen in 2008 is doubtful.
Mentel says: “Although banks could easily avoid regulation at the moment, this is not in their best interests because they need to be careful for their own benefit. Bankers do not want to find themselves in the same dire situation they found themselves in 2008.”
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Vickers’ UK bank ring-fencing will create more systemic risk
Download final ICB report (PDF)