More British banks expected to boost their balance sheets

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More UK banks are expected to follow Royal Bank of Scotland's lead and raise capital to boost their balance sheets in coming weeks as credit-crunch writedowns increase and trading conditions worsen.

Lenders have been weighing their options and talking to regulators in recent weeks over how to increase confidence in the financial system. No further rights issue is thought to be in the pipeline, but industry insiders think they will come.

Capital concerns have hung over the sector since the start of the credit crunch. Capital is the buffer that banks hold against unexpected losses to safeguard depositors' funds. For banks, liquidity is their ability to repay debt when it becomes due. Banks have increasingly used debt to fund their lending in recent years, and so both capital and liquidity affect a bank's ability to lend.

UK banks have used "leverage" by boosting their capital with non-equity financial instruments more than their European and US rivals, boosting the returns but also the riskiness of their balance sheets. During the long boom this was not a matter of great concern, but with fears increasing of a sharp economic downturn or recession, investors have homed in on banks' core equity capital as the real measure of their protection from disaster.

All British banks are adequately capitalised, according to the required ratios of capital to risk-weighted assets. But regulators around the world have said that, in the wake of the chaos wrought by the credit crunch, banks will have to hold more in future.

RBS's equity tier one ratio was 4.5 per cent at the end of last year, above the rough minimum of 4 per cent. But analysts believe the figure is inflated and that the "look-through" figure is close to the minimum. Big banks that could follow RBS include Barclays and HBOS. After RBS, analysts have argued that Barclays is the next most thinly protected, with equity tier one capital at 5.1 per cent. For Barclays to match the European average, it would need to raise £6bn, Citi analysts calculated earlier this year.

HBOS, Britain's biggest mortgage lender, could also join RBS. Credit Suisse analysts have said that, under the new Basel II capital rules, a downturn in the mortgage market would quickly consume more of HBOS's capital.

Barclays said there was no change to its policy on capital. HBOS declined to comment.

Bradford & Bingley considered raising cash recently but decided against doing so in the short term. But the buy-to-let mortgage lender could reconsider its position in light of RBS's imminent massive cash call. Banks have been reluctant to go first because investors usually take rights issues badly. The issuance of extra shares dilutes their holdings and suggests that management has got something wrong.

But a question for any bank thinking of following RBS is whether there will be enough investor appetite to support many more fundraisings. The cash calls could be a positive for lenders that take the plunge. Banks hold capital as a percentage of their loans, and if capital is tight, their ability to lend and generate profit is limited.

Bradford & Bingley is thought to have considered raising cash from shareholders partly to give it freedom to lend for fat margins in a less competitive market. A top-10 RBS shareholder said that if the extra capital would allow RBS to do profitable lending rather than sitting it out, the rights issue might be welcomed.

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