Bank of England policymakers have ordered British banks to make a more "honest" assessment of hidden losses on their balance sheets.
They warned that they will be forced to find ways to fill a shortfall that could be as much as £60-billion.
Sir Mervyn King, governor of the Bank of England, insisted that taxpayers would not be forced to plug any black hole at the bailed-out banks. He said Chancellor George Osborne, the finance minister, had made it clear that the government would not add to the £65-billion it had ploughed into the Royal Bank of Scotland and Lloyds Banking Group.
King called for banks to make an "honest and open statement" of what was on their balance sheets as the bank's new financial policy committee – set up to avoid a rerun of the 2008 banking crisis – called on the City of London watchdog to conduct a "proper valuation" of bank loans.
Andrew Bailey, the Financial Services Authority regulator who sits on the financial policy committee, immediately began to contact bank bosses to begin the process that will eventually lead to banks publishing how much capital they need to raise and how they intend to do so. They may choose to raise new cash, sell or close parts of their business or issue a new type of financial instrument known as contingent capital.
There was a muted reaction in bank shares, because the governor's remarks were interpreted as reducing the need for cash calls on investors, which shareholders had feared after previous quarterly meetings of the financial policy committee.
The policymakers are concerned about three main areas: the way that banks offer leniency to customers in arrears, a process known as forbearance; the scale of potential losses resulting from fines and compensation linked to "mis-selling" scandals such as payment protection insurance; and the way international capital rules allow them to set aside asset capital against the risk of the loans they hold. The financial stability report, published on November 29, estimated the cost of these three factors at £15-billion, £10-billion and £35-billion respectively – a total of £60-billion. However, the central bank governor said he was "not giving a single number" because this would be misleading and would depend on the circumstances of individual banks. The bottom end of the estimates produces an estimated £24-billion shortfall.
The United Kingdom's banks already have higher capital ratios than any of their rivals, but the financial policy committee is concerned about absolute amounts of capital. "We're not saying tomorrow morning be out there with the collecting tins," said King. He added that the subject needed to be addressed urgently, but it was manageable.
Deputy governor Paul Tucker, who this week lost out in the race to succeed King next summer when Osborne appointed the Canadian Mark Carney, said: "The watchword here is capital adequacy. There is no magic ratio. Capital adequacy requires that banks have honest balance sheets and they shouldn't be constrained by accounting policies."
Current accounting rules do not allow banks to make provision for estimates of future losses, only for losses that can be accurately forecast. Tucker said banks needed to set money aside on the basis of an estimate of future losses.
Another senior central bank official, Andy Haldane, admitted that the financial policy committee was concerned about the way banks were making provisions linked to the leniency offered to borrowers in the commercial property sector, which accounts for 50% of all business lending.
The policymakers argue that one reason the share prices of the big banks are lower than the value of their assets – at the end of June the discrepancy was £90-billion – is that investors are worried about potential bombs hidden in their balance sheets. – © Guardian News & Media 2012