June 21 (The following statement was released by the rating agency)
An "adjusted" 3% minimum common equity Tier 1 (CET1)
leverage ratio for UK banks is the most challenging aspect of the Prudential
Regulatory Authority's capital shortfall exercise, Fitch Ratings says. A shorter
implementation timetable naturally leads to less execution flexibility for the
The date by which these lenders have to reach the 3% PRA-leverage requirement
has not been disclosed yet, but it could be significantly earlier than the 2018
start date for the Basel III leverage ratio. The PRA estimates that two lenders
- Barclays and Nationwide - will fall short of the leverage requirement even
after taking actions to reach the 7% PRA-calculated CET1 benchmark.
Addressing the leverage shortfall in a short period could be challenging as
organic reduction in leverage takes time for some asset classes. It is easier to
reduce liquid and tradeable assets, so a short timetable would encourage banks
to reduce excess liquid assets. The main challenge lies in the PRA's requirement
that the target is met without reducing lending to the real economy, as the
government continues to press for wider access and more affordable lending.
For a bank with a less flexible asset structure, a short timetable for
implementation of the leverage requirement could spur issuance of core capital
instruments and encourage lenders to look for debt buyback opportunities to
boost CET1. Nationwide may issue a new form of mutual CET1 instrument called
core capital deferred shares. A move towards higher-yielding, higher-risk
mortgages and increased lending rates is also possible. The lenders' plans to
address the leverage ratio shortfall will be agreed with the PRA no later than
If the capital exercise is extended to other banks and building societies, we
would expect those involved in prime residential mortgages, which set aside
capital using the internal rating-based approach to credit risk to have to
improve their leverage ratio. A healthy and well-performing portfolio of UK
prime residential mortgages currently leads to risk weightings under the IRB
approach of 8%-10%, which means leverage can remain high.
We expect the capital exercise to reduce the variation in UK banks' reported
fully loaded Basel III ratios and to push the average higher by end-2013. This
should leave the banks well placed for the European Banking Authority stress
test in 2014 and increase the resilience of the sector. However, it has created
some short-term uncertainty during the process as there is limited detail on the
PRA adjustments and on when leverage shortfalls must be closed.
We believe the PRA has been conservative in making adjustments to capital and
risk weights. For example, the asset valuation adjustments were based on three
years of expected losses with no credit given for future income from the
portfolio. Fitch's credit analysis uses various stress scenarios, which may
differ to those of the PRA.
The PRA announced the completion of its capital shortfall exercise yesterday.
This involved eight major UK banks and building societies. The PRA made
adjustments to reflect a more prudent assessment of asset valuation, future
costs of conduct redress and risk weights.