A clear feature of the post Brexit referendum situation is a fall in bank share prices and perceived prospects. A chill wind has gone through not only UK bank share prices but also European ones. Bloomberg have published this morning the results of a stress test model produced by New York University and unlike the official efforts it was signalling problems before Brexit day.
Even before Brexit, the model suggested that banks were much more fragile than official stress tests indicated: As of May 31, it estimated that the largest banks in the U.S., U.K., Germany, France and Italy (those with more than $500 billion in assets) would have a combined capital shortfall of $998 billion.
After the referendum it felt that this had happened.
After the Brexit vote, the shortfall rose significantly. As of June 28, it stood at $1.163 trillion, an increase of $165 billion.
Actually the UK is not top of the shortfall list as unsurprisingly it is headed by the United States but food for thought is provided by the fact that France is in second place and not the UK. If we move to relative economic size I note that the shortfall is highest in France at 12% of its Gross Domestic Product whereas the UK is just over 10% and the US a relatively mere 2%.
Some care is need here as we learn something but need to take care how much. Whilst we note that one can construct a stress test which more than the token bank actually fails this one has its own flaw. That is the way that it only looks at the larger banks and so records more problems in countries which have some combination of larger economies and a more concentrated banking system. For example it therefore rates Italy as relatively low risk ( a capital shortfall a bit under 5% of GDP ) because many of its problems are relatively small banks. For example the non performing loans at Monte dei Paschi di Siena that have come to the attention of the ECB are very big for it ( 38 billion Euros) but small relative to the scale used here. That is why its shares are suspended as I type this at a price 7% below what was only yesterday a record low.
The UK economy
The banks do not exist in a vacuum as they both feed (hopefully anyway) and depend on the underlying economy. Bloomberg put it like this.
Why the pessimism? For U.K. banks, it’s pretty straightforward: Forecasters expect increased uncertainty and other Brexit-related difficulties to undermine economic growth, which in turn will narrow profit opportunities and make it harder for people and companies to pay back loans.
So troubled water is the immediate outlook as we await to see how we bridge it. This morning has brought further news from the front line or at least the Markit Purchasing Managers Index business surveys.
The PMI surveys indicate that the pace of UK economic growth slowed to just 0.2% in the second quarter, with a further loss of momentum in June as Brexit anxiety intensified.
That feeds into a picture where in terms of GDP growth we had been slowing ( 0.7% and then 0.4%) but also into a picture where that latest official industrial ( up 1.6% year on year in April) and manufacturing data had been relatively good.
A possible vulnerability
Whilst there may be issues over the mortgage book in time in the more immediate period we are more likely to see a signal from the unsecured credit which was growing so strongly.
Consumer credit increased by £1.5 billion in May, in line with the average over the previous six months. The three-month annualised and twelve-month growth rates were 10.7% and 9.9% respectively.
The Bank of England
It has a Financial Policy Committee for supervising the banks which is entwined in a spider’s web of bureaucracy with the Financial Conduct Authority and the Prudential Regulatory Authority. Last time the UK has a tripartite structure it failed utterly but I guess in Sir Humphrey’s world it was considered a triumphant model! As to the FPC itself apart from the Governor Mark Carney and perhaps Deputy Governor Ben Broadbent it is made up of individuals that very few people have ever heard of. I do know one other as some time ago I used to work with Clara Furse in the days before she became a Dame. In fact she did come to some attention as her appointment was criticised back in the day but the “serious concerns” of some MPs back then did not stop her being reappointed earlier this year.
What have they told us?
In the past they have continually told us that they are “vigilant”. I have been unkind and pointed out that they may have been vigilant about the Bank of England tea trolley but much less so about the boom in buy to let mortgage lending. This morning however the story has changed somewhat. Let us start with them looking firmly in the rear view mirror.
the UK commercial real estate (CRE) market, which had experienced particularly strong inflows of capital from overseas and where valuations in some segments of the market had become stretched;
Horse meet stable door as of course not only was the Standard Life property fund suspended yesterday but last week other commercial property funds imposed exit penalties. Moving on we see that the FPC has other concerns.
The FPC has monitored these channels of risk closely. There is evidence that some risks have begun to crystallise. The current outlook for UK financial stability is challenging.
So closely is the new “vigilant”. We also get some actual measures of the position.
Equity prices of UK banks have fallen on average by 20%, with UK-focused banks experiencing the largest falls….Between 23 June and 1 July, investment-grade corporate bond yields fell by around 25 basis points. Wholesale debt funding costs for the major UK banks fell by a similar amount. Overall bank funding costs — taking into account any increase in the cost of equity and the change in wholesale debt funding costs — are broadly unchanged since the referendum.
So there is some good news there which is that overall bank funding costs are pretty much unchanged although some have risen and some fallen.
What will they do?
This was announced at 10:30 am today.
The FPC reduced the UK countercyclical capital buffer rate from 0.5% to 0% of banks’ UK exposures with immediate effect . Absent any material change in the outlook, and given the need to give banks the clarity necessary to facilitate their capital planning, the FPC expects to maintain a 0% UK countercyclical capital buffer rate until at least June 2017. …….. It will reduce regulatory capital buffers by £5.7 billion, raising banks’ capacity for lending to UK households and businesses by up to £150 billion.
You may note that this change has an implied multiplier of up to 26 from the change in bank capital rules. To stop some of the money leaking away this a ban on increases in dividends and also stock buybacks have been imposed.
This is a quantity move by the Bank of England and is a type of what is called macroprudential policy. In terms of numbers in his press conference Governor Carney said that net bank lending in the UK was £60 billion last year or 40% of the change in capacity announced today. Also these rules apply to three-quarters of the UK’s banks who make some 90% of the total of bank lending. So far the Governor’s performance has been much more like that on the Friday morning post the Brexit referendum which reminds me of this from Meatloaf.
‘Cause two out of three ain’t bad
However there is a catch which is that as for example Governor Kuroda has found in Japan and Mario Draghi in Europe you can expand the supply of credit all you like at the central level but will there be demand for it? Also will the banks respond to the central changes and actually supply credit as we wonder how the banks will interpret the word “viable” that Governor Carney has on repeat today.
Also a long running theme of mine gets a bit of emphasis.
the financing of the United Kingdom’s large current account deficit, which relied on continuing material inflows of portfolio and foreign direct investment;