Jeremy Warner's Outlook: Basel II reason for cheer among bankers

While all attention in the City is focused on the gladiatorial battle for ABN Amro - a propos of which, rather dull results from Royal Bank of Scotland yesterday marked by poor figures from Citizens in the US - the rest of the banking world moves on, and in particular it worries about whether the economic boom of recent years is finally drawing to a close.

As I have argued, this is unlikely to be the case, but banking is a many-headed industry and it may well be that certain bits of it do indeed face tougher times. With a fast cooling housing market, the focus of this concern tends to be the mortgage banks, where share prices have been under pressure.

Yet even here, the bear case has been overstated. It might sound an odd thing to say, but there is in fact a big difference between the housing and mortgage markets. As interest rates rise, the number of housing transactions will slow and, in certain parts of the country, there may be financial distress, with falling prices and increased repossessions. Yet provided the economy overall remains healthy and unemployment low, there is unlikely to be a crash.

Meanwhile, the mortgage market should continue to grow right through this soft patch. Indeed, it might even accelerate as people shop around for the best mortgage deals and refinance accordingly. Paradoxically, then, even as the number of housing transactions fall, the velocity of mortgage activity should increase.

There are bound to be winners and losers in this process. Northern Rock and Bradford & Bingley, whose business models rely on stealing customers from larger, more established mortgage providers, are sitting pretty. Mortgage providers that don't put their back book on the same terms as they are offering to attract new customers will suffer.

The other factor which has not been sufficiently appreciated by the City is the degree to which new, Basel II, capital adequacy rules will enhance the capacity of mortgage banks for share buybacks and dividend payments. Only Alliance & Leicester has so far attempted to detail exactly how Basel II might affect capital.

Similar stabs at the issue are expected to be made by both Northern Rock and Bradford & Bingley with upcoming interim results. As Credit Suisse's banking analyst, Jonathan Pierce, commented in a circular yesterday, it's complicated, but the bottom line is that mortgage banks are considered under the new rules to be a relatively better credit risk than others and therefore to need less capital.

The size of the excess is anyone's guess, but it could be as much as £500m apiece. Remember, it is not just the risk weighting applied to the mortgage asset which counts; it is also the amount of "Pillar II" capital required by the regulator. This is much more difficult to assess through outside analysis, but, in Northern Rock's case, it may be rather lower than generally appreciated because of the imminent sale of the bank's commercial loans portfolio. The effect will be further to enhance Northern Rock's capacity for capital returns.

All this good news is no doubt small beer compared to what's going on in the higher echelons of British banking, where the battle is on with a vengeance for the prize of most pre-eminent banker of his generation. Up until just a few months back, there was no doubt about who was the rightful heir to Sir Brian Pitman of Lloyds TSB, the previous incumbent. Nobody would have disagreed but that it was Sir Fred Goodwin, chief executive of Royal Bank of Scotland and the mastermind behind the National Westminster Bank integration.

But now there is another pretender to the throne - John Varley of Barclays. If he succeeds in acquiring ABN, Barclays will leapfrog RBS to become Britain's second largest bank after HSBC, firmly entrenching itself as a member of the global super league. It is this personal element to the battle for ABN which makes it both so fascinating, and potentially dangerous for shareholder value.

Assuming Sir Fred's consortium doesn't founder on the La Salle sale, or otherwise fall apart because of its members' differing agendas, Barclays will need to sweeten its offer and introduce a cash element to stay in the game. We have to assume the consortium is fully prepared to better anything Barclays has to offer.

The chances of an outcome which destroys more value than it creates rises the higher the offers go. Sir Brian Pitman made Lloyds TSB into one of the largest banks in the world by market capitalisation. But in the race for the top, Lloyds ran out of road and lost its way. High stakes indeed. Perhaps best just to stick to mortgage banks.

Brown helps to fund his own nemesis

Why the song and dance all of a sudden about the head honchos of private equity paying less tax than the cleaning lady? Yes, alright. I know it is because someone important in the industry, Nicholas Ferguson of CVG Capital, has admitted it may be hard to justify. Yet this has been apparent for an awfully long time now. What's more, this bizarre anomaly exists under arrangements agreed by our very own Chancellor, soon to be prime minister, Gordon Brown. It was he who introduced the taper relief - which reduced capital gains tax to 10 per cent for unlisted business assets - that makes it possible for private equity partners to pay so little tax, and it was he who implicitly agreed the Revenue's memorandum of understanding that allows the private equity industry to treat payment in shares as capital rather than income.

It was therefore somewhat surprising to hear him at the GMB conference in Brighton yesterday pledging to "deal with this important issue". This is his very own policy which he is now promising to reform in the interests of "justice and equity".

There is no obvious answer to why the Government should have agreed these arrangements, other than highly effective lobbying by the private equity industry. Taper relief was originally introduced as a way of encouraging entrepreneurial activity. Those who founded their own business, or invested in start-ups, could expect to enjoy the fruits of any success with an effective 10 per cent rate of capital gains tax, rather than the established 40 per cent. The move helped establish Mr Brown's pro-business credentials.

Private equity's extensive use of the tax perk is a very long way from its well-intentioned purpose. Partners receive the vast bulk of their remuneration in the form of free shares in the companies they buy - so called "carried interest" - and therefore pay only 10 per cent on sale, rather than the normal income or capital gains tax rate of 40 per cent.

This is a tax treatment which has been agreed by the Revenue during Labour's period of government, and would thus surely have been given the nod by the Chancellor himself. The effect has been to help make London undisputed centre of Europe's private equity industry, and is therefore very much a part of London's reputation as the super-rich capital of the world.

The City has behaved with its customary gratitude for this act of generosity, doled out at obvious risk to Labour's grass-roots political support. The lion's share of political donations now flowing from those that Brown's Britain have enriched beyond the dreams of avarice go straight into David Cameron's election warchest. Labour's support for the City may have been in the country's best interests economically, but politically it might be about to backfire spectacularly. Mr Brown may have helped fund his own nemesis.

O'Leary's gloom: more bluff?

Three years ago, Micheal O'Leary, chief executive of Ryanair, warned of an imminent bloodbath in low-cost airlines. The idea was presumably to scare off potential rivals, then queuing up to enter the industry. It worked. New entrants were limited and there was no bloodbath. So is he crying wolf again by being so downbeat about the future? Almost certainly.

j.warner@independent.co.uk