The Motley Fool Previous Page

Banking on Quicksand

Andrew Marder
March 27, 2013

U.K. banks are sitting on a $38 billion hole, according to the Bank of England. The regulator announced the shortfall today but did not say which banks were looking thin. The move to shore up reserves is driven by the fear of weakness in the European economy and a need for banks to hit the capital requirements of Basel III. By 2018, banks will need to meet a 7% capital ratio, and recent crackdowns have made that a harder target for banks to hit.

While not every bank is in dire need, the consensus is that both RBS (NYSE: RBS) and Lloyds (NYSE: LYG) are going to need to go back to the table. HSBC reportedly has one of the largest capital ratios, which was bolstered earlier this year when the company closed the sale of its Ping An holding. In the middle sits Barclays (NYSE: BCS), which has gone on record to say that it will work through 2013 to improve its capital position.

As the deadline for capital requirements approaches, investors need to watch out for banks that fall short. Raising capital will mean selling off valuable assets, diluting shareholder earnings through new offerings, or cutting back on dividends to retain extra capital.

Loops get closed
Earlier this month, the Basel Committee announced that it was going to treat insured risk differently, making it harder for banks to boost their capital by simply insuring against default. Up to this point, banks had been able to purchase protection for their risky assets, in effect making them less risky. While the premise is sound -- and not nearly as close to the rererereinsured mortgage portfolios of 2008 as one might think -- banks were abusing the practice. Shocker.

The problem was that banks could buy the insurance, but spread their premiums out over a long timeframe. That meant banks profited immediately on their capital requirements, but didn't take on the risk of having to pay off the insurance for years. That deferral of risk is one of the things that central banks and regulators have been trying to fight, and Basel decided to crack down on the system.

To this point, banks from Citigroup to Goldman Sachs had been reportedly engaging in the practice to help their balance sheets. While those firms will still be able to insure their risk and add to their capital, they must now recognize the costs associated with that insurance upfront.

Sticky wicket
I know it's not really like a sticky wicket, but come on. Banks in the U.K. have been fighting to meet these new requirements since their inception. Lloyds is now