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29th May 2020
Scope says UK banks to manage through challenging times with regulatory encouragement
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Scope expects major UK banks to manage through the pandemic, thanks to their earnings capabilities and capital. Revenues will suffer and credit losses will rise but as long as they help support the economy, banks will likely get regulatory support.
Banks are being presented as part of the solution to adverse economic effects of the pandemic. “However, as banks play their role by supplying credit to the economy, there is a risk that non-performing exposures will materially increase,” cautioned Pauline Lambert, executive director in the financial institutions team of Scope Ratings and author of a report out this week. “And while regulators will not necessarily judge elevated levels of impairments and reduced capital buffers in the same vein as before, investors and creditors may rightly have differing views.”
In the Bank of England’s recent stress test modelling the potential impact of the pandemic, UK banks suffered from significant credit losses on their loan portfolios but remained well above minimum regulatory capital requirements. Low interest rates, extensive fiscal measures, mortgage payment holidays and the more resilient position of households overall entering the stress help to moderate the level of losses. Meanwhile, the assumed non-payment of dividends, a halving of variable remuneration, and cuts in coupons on AT1 securities as required sustain banks’ capital positions.
“The capacity of the banks to cover estimated 2020-2021 credit losses from pre-provision income varies,” said Lambert. Earnings over the last few years may not be entirely representative as some were restructuring their businesses and there were also material conduct charges. At the same time, future pre-provision income will be under pressure from reduced client activity, additional costs and forborne revenues related to supporting customers as well as lower margins due to interest-rate cuts. As a second line of defence, banks have capacity to absorb elevated impairments from capital in excess of requirements.
The credit costs of major UK banks increased materially in 1Q 2020, compared to 2019. While there were no significant changes in Stage 3 exposures or non-performing loans, some banks experienced higher credit costs due to individual corporate exposures. The primary drivers of increased credit costs were changed economic assumptions and management overlays, with increased provisioning for Stage 1 and 2 exposures.
Management teams were hesitant to provide firm guidance on where credit costs may end up for the year, although provisions are being recognised earlier rather than later because of IFRS 9. HSBC gave a range of $7-11bn, equivalent to a cost of risk of 0.7% to 1.0%. Barclays indicated that provisions may be around £5bn(1.3%). Meanwhile, RBS noted that quadrupling the cost of risk incurred in 1Q would be as reasonable a guess as any(0.9%).
At the levels guided to, banks should be able to absorb these impairments from earnings. “Extrapolating from the BoE’s illustrative stress scenario, we arrived at an estimated cost of risk for individual banks ranging from 1.1% to 2.5%. At these higher levels, banks would likely need to tap into available capital reserves,” Lambert added.