Last week we looked at what new powers regulators have gained since the crash to protect consumers and the financial system. Today we examine at the environment for banks and building societies a decade on from the crash, specifically asking the question: what protections are in place to stop another Northern Rock or Royal Bank of Scotland failure happening again?
The most obvious change is that the banking sector is subject to considerably more scrutiny from regulators, governments, the media and its customers. UK banks are subject to a combination domestic, EU and global legislation.
Capital buffers have been boosted, investment banking divisions – seen as the riskier part of the business – have been scaled down and firms have been subjected to numerous “stress tests” under different economic scenarios. Central banks have also helped boost bank balance sheets through their quantitative easing programmes, buying government bonds from financial institutions.
Since the crash, banks have also paid billions of pounds in fines for range of “misconduct” issues, including mis-selling sub-prime mortgages in the US and Libor-rigging.
Starting with UK regulation, the Bank of England’s oversight arm, the Prudential Regulation Authority (PRA) takes a top-level view of 1,700 banks, building societies, credit unions, insurers and the largest investment firms. The PRA aims to promote the stability of the UK financial system, and it categorises finance firms under four headings – P1 is the most important category, which covers firms whose failure could cause significant damage to the marketplace and consumers.
Under PRA “ring-fencing” rules, banks must separate out retail from investment banking. The Financial Conduct Authority can levy fines on specific firms – the most notable this year being the £163 million imposed on Germany’s Deutsche Bank, for failing to maintain adequate money-laundering controls between 2012 and 2015.
Significant Government Intervention
UK Government's financial intervention in the banking sector has been significant over the last 10 years. The most visible case has been that of Royal Bank of Scotland (RBS), which was nationalised in 2008 and is still majority owned by the state after a £40 billion-plus bailout in 2008.
Morningstar equity analysts rate RBS as a three-star stock, with no outstanding competitive advantage or “moat” and a “very high” uncertainty rating. “While the bank has posted some improvement in its core businesses, we are maintaining our fair value estimate of 265p and our no-moat rating, considering ongoing restructuring and the downside risk of outstanding litigation and conduct issues,” said analyst Derya Guzel after the firm’s first half results in August.
Lloyds Banking Group (LLOY), on the other hand, has emerged from the crisis in better shape, having paid back the entire bailout money and restarted dividend payments to investors: “After its restructuring, we believe the bank’s business model is well-positioned for the challenges that Brexit poses to the operating environment and possible changes in the regulatory framework,” Guzel said.
UK banks must also meet demands from EU regulators, most notably the European Banking Authority (EBA), which has been running periodic “stress tests” for Europe-wide banks – alongside the Bank of England, which runs similar tests. Investors have been focusing on banks’ capital ratios under various scenarios: the biggest UK banks have “core tier one” ratios of around 14%, but these would drop in the event of a UK or global recession.
Due to British banks’ expansion overseas during the boom years, their activities now fall under the jurisdiction of US authorities. The Department of Justice is still investigating Royal Bank of Scotland for its role in selling mortgage-backed securities before the financial crisis, and has already fined the bank billions. UK banks have regulatory exposure to the US Securities and Exchange Commission (SEC), and are subject to regulations under the Dodd-Frank Act, which President Obama signed into law in 2010.
Firms are also subject to global regulation under the Basel Committee on Banking Supervision, whose latest iteration tightens up rules on banks’ capital buffers. US and European banks are subject to Basel III rules.
Would the State Step in Again?
Given Royal Bank of Scotland’s long road to recovery since the crash, and the Government’s controversial ongoing support for the bank, it is debatable whether the British state would step in again on such a scale. With RBS still on the government books, politicians would struggle to convince voters that bank bailouts represent their best interests.
The global economy is in better shape than during the financial crisis, so banks are under less pressure than they were at that time. Consumers default less on personal loans, credit cards, and mortgages, especially with interest rates low across the developed world. Credit markets are more stable and more liquid.
Banks have built up their balance sheets to withstand adverse events – and there is an argument that an event of the magnitude of the financial crash will not occur again within most regulators’ timeframes. But there are still risks, not this time from a lack of regulation, but from external events such as Brexit, a stock market correction and a nuclear conflict in Asia-Pacific.