Since Mark Carney became BOE Governor on July 1, headlines have focused on his leadership of the Monetary Policy Committee (MPC). Less discussed is his other responsibility—namely, his role as regulator in chief. Yet this could have just as big an influence as monetary policy on the UK economy and stock markets, and Monday’s UK banking news suggests Carney has his work cut out for him.
The UK’s regulatory environment has weighed on bank lending since 2009. The MPC and Treasury have tried to boost lending through schemes like “Help to Buy” and “Funding for Lending,” but regulators have whacked the banks with threats to raise capital requirements, mandate countercyclical capital buffers and set the leverage ratio above Basel III’s minimum 3%. This year, BOE regulators have ordered banks to comply with Basel III’s 7.5% Tier 1 capital ratio by year-end—six years ahead of the international schedule. As a result, banks raised about £13.7 billion in capital during Q2, and lending fell once again.
The BOE is forcing the biggest banks to comply with the 3% leverage ratio ahead of schedule, too. According to the BOE’s Prudential Regulation Authority (PRA), only two of the eight biggest banks have a shortfall, but these happen to include the UK’s biggest mortgage lender and second-biggest bank. Both have spent weeks negotiating their compliance deadlines with PRA. Former Governor Mervyn King favored a 2013 deadline, and some of his deputies continued pushing for this after he left. Carney, however, resisted the calls—along with calls to bump the ratio to 4.5%—suggesting he’s open to giving banks a bit more wiggle room than his predecessor.
In recent days, reports have suggested PRA is eyeing a 2014 or 2015 deadline, which gives lenders somewhat more flexibility than a 2013 phase-in. But they’ll likely still have to make some adjustments, which could hinder their ability to lend for a while. If they had a 2018 deadline like their peers globally, they could likely make up the shortfall gradually by retaining earnings while still lending at a reasonable pace. But to comply with an earlier deadline, they’ll likely have to make fewer loans, and one institution is reportedly planning to issue £7 billion in new equity, diluting earnings.
Simply, the UK needs more lending, not less. And to get it, regulators need to let things be. Bank lending is businesses’ largest financing avenue. As Exhibit 1 shows, since banks started pulling back, total corporate funding has floundered, making it difficult for businesses to finance growth-oriented spending. The larger, most solvent firms can use their £750 billion cash reserves as collateral to get funding from investors, but bonds can’t fill the shortfall for all UK businesses. The lack of investment capital is a big reason why Gross Fixed Capital Formation has largely stagnated since the recession ended in 2009. (Exhibit 2) Contrast this with the US, where loan growth, though slow, has been positive and business investment has been strong.
Exhibit 1: UK Corporate Funding Breakdown (Quarterly)
Source: Bank of England, as of 7/29/2013.
Exhibit 2: UK Gross Fixed Capital Formation & GDP (Quarterly)
Source: Office for National Statistics, as of 7/26/2013.
Small and mid-sized businesses (SME) have it the worst. They largely don’t have the clout to issue corporate debt, and banks generally see them as riskier than larger, well-capitalized firms, so they’re less willing to take the hit to their balance sheet. News of June’s upturn in SME lending received great fanfare Monday, but it was only the fourth increase since BOE records begin in April 2011, and it was driven more by falling repayments than an increase in funds lent. (Exhibit 3)
Exhibit 3: UK SME Lending
Source: Bank of England, as of 7/29/2013.
The British Bankers’ Association has a longer dataset for small businesses only, which tells a similar story—falling repayments have driven the few net lending increases since 2008. (Exhibit 4) As a result, a big component of the UK economy—and a vital contributor to growth—is struggling.
Exhibit 4: UK Small Business Lending
Source: British Bankers’ Association, as of 7/26/2013.
Most telling about the influence of regulatory policy, in our view, is the fact lending has continued falling even as the yield curve has steepened. A wider spread between short and long rates gives banks a higher potential profit on the next loan made—an incentive. But higher capital requirements are a disincentive, and at the moment, this seems a more powerful force.
How Carney addresses this will be key for the UK economy looking forward. If, under his leadership, the BOE stops hitting banks with costly new rules and capital requirements exceeding international standards, banks can likely resume lending at a more normal rate, businesses can obtain more funding, and business investment can find a sustainable upward trajectory. His early resistance to the BOE’s regulatory hawks is an encouraging sign, but there will be plenty more tests over the next several months.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.