If UK banks were hoping for an easier ride after Brexit from regulators on the capital buffers they must hold against shocks, they have suffered an early disappointment.
At first, second and third glance, the UK’s proposals for implementing the latest package of global bank capital standards clash with the government’s pledge to make the City of London a more accommodating place for financial services after the EU divorce.
The Bank of England, even by its own account, is going for a stricter implementation of the rules than the EU. Authorities in the bloc are considering so many deviations from the new global standards that the EU risks material non compliance with them, according to its top regulators.
UK bank executives and their lobbyists are largely unpersuaded by the BoE’s assertion that a stringent approach will help them, a claim that hinges on the value investors place on high standards. The bankers argue that investors will be more concerned about the raised costs and lower returns that go hand in hand with what they see as gold-plated standards versus those in the EU.
Some of the granular details in the BoE’s proposals are also attracting spiky criticism from bankers who question how they fit with high-level promises from politicians such as chancellor Jeremy Hunt to turbocharge the City’s growth with reforms.
The issue of how banks should treat small business loans is one area of contention. In its efforts to make capital requirements more sensitive to risks in the property market, the BoE is proposing a tweak to global rules, making small business loans backed by commercial property effectively more costly for banks than those for equivalent firms backed by no collateral.
“That’s the bit we’re most alarmed about,” a senior executive at one UK lender says, describing the measure as “completely illogical” and “really really damaging” since a high percentage of loans for small and medium enterprises are secured on property.
The UK’s approach to corporate loans is also attracting scrutiny. The global standards package — known as Basel 3.1 by regulators and Basel 4 by virtually everyone else — imposes new rules on lending to businesses that do not have credit ratings, a category that most UK and EU corporates fall into. To determine what capital buffers a bank needs, regulators require banks to estimate their assets after adjusting for risk — multiplying by a percentage factor that takes into account the likelihood of loss.
The UK proposal offers banks a choice. They can apply a 100 per cent risk weighting on all their loans to unrated corporates, in line with global standards. Alternatively, they can apply a 65 per cent risk weighting on loans to high quality unrated corporates and a 135 per cent risk charge on lending to lower quality ones. UK bankers say this will leave them at a disadvantage to EU banks, which will benefit from a more benign regime at least for a transitional period.
It could also lead to a split in the UK market that will ultimately hurt borrowers. Bankers say lenders will have to choose a regime that is better for either high quality loans (the 65 and 135 per cent option) or low quality (the 100 per cent weighting on everything). That choice will change the market’s dynamics, they say.
A bank that has opted for the 100 per cent risk-weighted regime will find it difficult to compete for high quality loans with a lender that chose the regulatory alternative with lower charges for such loans, resulting in less competition in UK corporate lending. There are other gripes around areas like mortgage valuation and trade finance, where the BoE has opted for a more conservative treatment than the EU.
A senior executive at another large UK lender says the proposed changes could give EU competitors “a material entrenched benefit” in individual products. UK banks will then back away from those areas, even though they have ample capital overall, because banks look at products individually, the banker argues.
But the saga isn’t over yet. The BoE has opened a four-month consultation on its proposals and one senior banker says it is more open than the previous ones. Banks are preparing data on the potential unintended consequences of the proposals, which the BoE appears keen to receive and review. Executives say they are reasonably hopeful of ironing out issues “around the edges”, but less so of getting the UK to a place that is close to the EU.
Their success, or otherwise, will test another of the big promises of the UK’s post-Brexit regulatory approach — more “agile” and responsive decision making compared with the EU.