Regulators risk causing unnecessary pain to investment banks
Tough regulations could hit lenders’ profits, spark lay-offs and negatively affect Europe’s economy
European investment banks look increasingly like a dying breed. The financial behemoth that operates globally — as a trading house, issuing equity and debt, and advising on takeovers — is now exclusively a US beast.
A couple of weeks ago, the Financial Times published several stark analyses of the shifting balance of power in global investment banking. It revealed that while eight years ago half a dozen banks generated the bulk of their business in investment banking, today only a couple (Goldman Sachs and Morgan Stanley) still do.
The biggest retrenchments have been European. The shrinkage at Royal Bank of Scotland and UBS has already been dramatic. Barclays has begun to pull back from some regions and products, while Credit Suisse and Deutsche Bank, both of which have new plain speaking chief executives, look set to follow suit.
This, of course, is what regulators and national governments wanted. The financial crisis highlighted both the danger and taxpayer cost of banks being bigger than their host countries, as they were in Switzerland and the UK. New rules and tough talk from politicians have understandably deterred European banks from investment banking. US rivals now command double the market share.
It is fashionable to see this shift as a positive. But the next round of regulations could undermine the banks to such an extent that it risks undermining their corporate customers as well as Europe’s broader economy.
Nowhere is that truer than in the UK, where the likes of Barclays and HSBC face more than three years of structural overhaul to comply with incoming rules on ringfencing — the circuit-breakers that will be inserted between high-street banking and investment banking operations.
HSBC reminded customers of the looming change last week, when it announced the rebrand of its UK high street operations as HSBC UK. The subtlety of the change belies the potential upheaval that ringfencing could entail, particularly for Barclays and HSBC.
Quite how much of a headache it will cause will not be clear until the Prudential Regulation Authority publishes final rules on the topic next month. Will capital be transferable across the ringfence via dividends or other means? Will funding lines between the two be capped as with any counterparty? How high will capital strength ratios have to be for both ringfenced and non-ringfenced entities?
Banks are hoping that the government’s softening position on the City more generally will convince the regulator to be generous in its interpretation of the rules.
A lot is hanging on the decision. If the PRA takes a hard line, banks might have to find fresh capital. And raising finance in the bond markets, crucial for the investment banks trapped in non-ringfenced entities, could become more expensive. (Without recourse to the diversification of earnings or deposits on the other side of the new barrier, the non-ringfenced bit of a big bank is riskier.)
Some credit rating agencies think the impact may be slight. Fitch believes the rating benefit from global requirements to hold new buffers of “total loss absorbing capital”, TLAC in banking jargon, may offset the negative rating impact from UK ringfencing. It points to the minimal ratings impact from Switzerland’s “ringfencing lite” regime.
But rival Standard & Poor’s suggests there could be significant downgrades in the offing. The non-ringfenced part of a big bank may end up with a rating six notches lower than the ringfenced part, S&P says. If so, the gap between UK investment banks and their foreign counterparts would be further magnified. US competitors meanwhile are enjoying upgrades, thanks to the TLAC effect.
But why care, if safer British banks protect British taxpayers from more bank collapses and bailouts?
The truth is, a system can be made to be too safe. So safe that profitability suffers, staff are laid off and tax receipts decline. So safe that the UK and Europe have to rely increasingly on US investment banks in a less competitive, and therefore more expensive, market.
Given the other rules already introduced to make banks safer — more capital, better funding structures and so on — a touch of pragmatism on the superfluous exercise of ringfencing would surely be wise. Extra constraints on some of Europe’s biggest homegrown banks could inflict unnecessary pain on the continent’s fragile economy.