The UK capital framework will consist of a risk based approach, a stress testing approach, and a leverage ratio approach. The consultation paper published on Friday (11 July) sets out the FPC’s thinking of how the latter should be implemented.
As with the other two elements of the capital framework, the UK appears to be taking a hard line approach to the setting of capital requirements. The FPC proposes that leverage ratio requirements should demonstrate symmetry with the risk based requirements. That is, a base requirement plus a set of buffers on top. BNP Paribas experts think perfect symmetry would suggest a total “go-to” requirement including buffers (capital conservation, GSIB, countercyclical and management buffer) of broadly double the minimum base requirement.
Right now, they don’t know what this base requirement will be, but it seems prudent to assume a figure of 3% given what we are seeing in other jurisdictions that have adopted a base plus buffer approach, and the fact that 3% is the de facto internationally agreed minimum today.
Barclays appears to face the biggest challenge from leverage proposals
BNP Paribas analysts do not intend to talk in detail about specific companies here. However, the main issue obviously surrounds Barclays, which has a specific plan to reduce its leverage exposure from GBP1.4tn in 2013 to c.GBP1.1tn by 2016, a reduction of close to GBP300bn driven primarily by downsizing its investment bank.
Although this will boost its leverage ratio over the next few years and dramatically reduce its capital shortfall relative to the estimates above, the bank’s own target is currently only >4% by 2016 (vs 3.3% CRDIV fully loaded at 1Q14).
Stripping out the AT1 issued to date this would fall to >3.6%, well short of the potential equity go-to requirement that we have discussed. This would leave Barclays having to further curb its leverage exposure or cap dividend payments over a long period of time, neither of which is particularly helpful for shareholders.
Lloyds remains the best placed UK bank from a capital perspective
The bank that continues to look best positioned is Lloyds. For while its equity leverage ratio is not quite as solid as HSBC or Standard Chartered, the capital build will be significantly assisted by the run-down in the DTA (currently depressing the leverage ratio by 65bp.
Furthermore, it is far better positioned than most with regard to the total leverage ratio courtesy of its AT1 issue. Finally, and importantly, it is well positioned to meet its risk based capital requirements by the end of next year. Indeed, on this final point it is important that investors remember that leverage is only one part of a three pronged capital framework in the UK.
Market watchers at BNP Paribas continue to believe that banks will be required to meet all three components before management are given substantial discretion in the setting of dividend payments. This does not bode well for the dividend paying potential of sector, with the exception of Lloyds – where we continue to forecast a 7.1p DPS in 2016.
You can read here the whole BNP Paribas’ UK Banks report.