HSBC’s £10bn of ring-fence fears for UK banks

Posted by Joe Rennisonon Jun 23 17:30.

That ring-fencing idea — it’s just posturing, right? Right?

No?

We don’t know but a report out Wednesday by HSBC says we should take it very seriously given its broad political support.

And it looks like the markets are also doing so on Thursday:

Barclays, Lloyds Banking Group and Royal Bank of Scotland shifted back 6.6p to 252.3p, 0.31p to 47p and 0.27p to 38.65p respectively following HSBC’s decision to downgrade its advice on all three to “neutral” after calculating that the proposals from the Independent Commission on Banking (ICB) could cost them over £10bn.

That from the Independent.

HSBC’s decision to downgrade all three UK domestic banks is detailed in the note. It’s unsurprisingly all about the cost to the banks of losing UK sovereign support for activities lying outside of the ring-fence. This will lead to (1) funding, (2) liquidity and (3) capital costs. Here’s HSBC’s reasoning:

That suggests credit ratings should converge towards the ‘stand-alone’ ratings; a decline of two-to-five notches if applied today. And that, in turn, should lead to higher funding costs.

Rating agencies allocate two ratings to UK banks – an overall rating, which includes the benefit of support, and a stand-alone rating (which does not). For the UK banks, the latter are two to five notches below the overall rating (Moody’s). Logically then, absent sovereign support we would expect at least two ratings downgrades for the NRFB (non-ring-fenced bank).

On top of which, we would expect the NRFBs will need to lengthen the maturity of funding to counter the enhanced pro-cyclicality that the loss of sovereign support will bring. That also has a cost.

Unable to rely on the profits and diversification that the UK Retail bank brings, the NRFB should be a weaker stand-alone proposition, which could lead to further downgrades, we estimate maybe a further two+ notches.

And here’s what HSBC thinks will be the impact of the ICB proposal on capital requirements:

To avoid the standalone ratings falling, we believe banks will need to raise capital levels; we estimate core Tier 1 ratios may need to be in the region of 13-15% in the NRFB.

In an ideal world the UK banks would pass on the higher cost of funding and capital to customers. But in many cases the NRFB activities will be in internationally competitive markets; passing on the higher costs would simply lead to market share loss. Hence, we would expect much of the cost of the ring-fencing will be borne by shareholders.

What does all this mean? HSBC reckons that the potential damage to the pre-tax profits of RBS, Barclays and Lloyds Banking Group alone could run to £10bn. This figure varies between wide and narrow ring-fencing – the difference being whether to ring-fence UK retail and UK corporate banking activities, or just the former.

Here’s the summary table:

And they add:

That is before we allow for any risk to corporate deposit outflows (with a knock-on requirement to further deleverage), incremental administration costs or the broader impact of an almost inevitable slowing of UK GDP.

Perhaps them UK taxpayers won’t be so protected after all.

Related link:
Lloyds lags behind after ICB report – FT Alphaville
Whoops! Ring-fencing retail banks could backfire – FT Alphaville

This entry was posted by Joe Rennison on Thursday, June 23rd, 2011 at 17:30 and is filed under Capital markets. Tagged with , , , , .

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