Regulatory demands are depressing banking profitability in Britain.
Having successfully passed the European Banking Authorty’s stress tests on October 26th, several British banks announced their quarterly results this week. Their home country’s booming economy might have been expected to have produced large profits for them. But the picture was in fact much more mixed. Although the domestic market for financial services has perked up, they have been battered by a seemingly never-ending list of fines for bad behaviour. And new rules on leverage, announced by the Bank of England on October 31st, are likely to drag down shareholders’ returns even further.
On October 30th, Barclays unveiled earnings figures that beat analysts’ expectations. However, it was also forced to set aside £500m ($800m) to cover costs that may arise from an ongoing investigation into alleged manipulation of the foreign-exchange market. Then on October 31st, Royal Bank of Scotland (RBS), which is 84% owned by the taxpayer, announced that it had made a profit for a third consecutive quarter—the first time it has achieved such a feat since its bailout. But it also was forced to set aside £780m to cover litigation and fines. The largest chunk of this was a £400m sum set aside to cover costs arising from the same probe as affected Barclays’ results; there was also another £100m reserved to compensate customers who were mis-sold payment-protection insurance.
And RBS and Barclays are not the only banks being forced to lay aside huge sums for compensation or pay crippling fines. The latter have become so frequent that Andrew Bailey, boss of the Prudential Regulation Authority, a regulator, has warned that they could increase systematic risk by pulling down on banks’ capital ratios.
Worse still, investment-banking profits are not making up for the malfeasance. At Barclays, they fell by 38%, while what remains of RBS’s investment bank made a £557m loss. A similar picture can been seen at Standard Chartered, another bank, which recently announced a 16% fall in profit, mainly caused by the weakness of its financial-markets division.
As a result, British banks have continued to shrink their riskier operations. Barclays is pulling back from the trading of bonds, currencies and commodities, and wants its investment-banking activities to take up no more than 30% of its balance sheet, down from more than 50% before the financial crisis. RBS wants to focus on British retail banking.
Across the board, banks are continuing to trim costs to regain their profitability. RBS has said that it wants to cut its costs by £1 billion in 2014, having shed almost 10,000 staff last year. On October 28th Lloyds Bank announced that it will close 200 branches and shed 9,000 jobs in a drive to get more of its customers to bank online.
Whether that will be enough to counteract the growing regulatory drag on profits is another question. Many analysts point out that pay has yet to adjust to lower banking profits. Before the crisis, 75 pence went to shareholders for every pound going to staff. Now, the ratio is just two pence to a pound. And that burden on shareholders is about to get worse, thanks to the Bank of England’s new “leverage ratio”, of 3% and more “globally systemically important banks”. That means that banks may have to possess more than £3 in capital for every £100 they lend out. Although this was much less biting than some had feared, it may still reduce the amount British banks are able to lend to customers in the future. The majority of British banks already satisfy the new requirement, but those that do not will have to curb their lending, issue more capital, or hold back on dividends. The road to recovery for British banking has already proved long and painful—and there is no end in sight.
Source: The Economist
