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Banks' Capital: Now We Know the Worst

Tony Reading
April 2, 2013

LONDON -- The threat of being forced to raise more capital has weighed on banks since last November, when the Financial Policy Committee pronounced that U.K. banks in aggregate could be 50 billion pounds undercapitalized.

The Committee last week halved its estimate to 25 billion pounds. Banks have to raise that by the year-end, but around half is covered by initiatives already in train. So the real shortfall is a much lower 12 billion pounds.

It's no surprise, then, that the report was greeted with a jump in the share prices of the three banks most affected, RBS (LSE: RBS) (NYSE: RBS), Lloyds (LSE: LLOY) (NYSE: LYG), and Barclays (LSE: BARC), though the turmoil in Cyprus left them overall down on the day.

The FPC has not revealed how the 12 billion-pound capital shortfall is split between individual banks, but the Financial Times says it includes 6 billion pounds for RBS, 3 billion pounds for Lloyds, and around 1 billion pounds for Barclays.

There's some political expediency at play. Judging how much capital a bank needs is a subjective process, and the FPC chairman, Bank of England Governor Mervyn King, is a capital hawk. But the government said it wouldn't put more equity into RBS and Lloyds, so if the FPC had been too harsh, then both banks could have found themselves between a rock and a hard place.

Higher capital ratios also reduce banks' ability to lend, with knock-on effects on the economy. With Mervyn King on his way out, policy is shifting toward the perceived greater emphasis on growth of his successor Mark Carney. Conveniently, the FPC lowered its yardstick for minimum capital Tier 1 ratios (after its judgemental adjustments) from 9% to 7%.

Some of the under-provided risks might remain, but the threat of banks being forced to raise dilutive equity has diminished.

Capital raising
Fundamentally there are three options to cover the shortfall: raise new capital, shed assets, or conserve cash.

Barclays is expected to make another issue of contingent capital bonds after its $3bn issue