UK Banking -SPECIAL REPORT

UK Banking

SPECIAL REPORT

20th January 2009

When I joined the Chartered Bank (then part of Standard & Chartered Banking Group) in 1976 the UK banking scene offered customers huge competitive opportunities both in the domestic and international markets but as banking consolidation accelerated it became abundantly clear that customers became third choice after shareholders and bank employees as City bonuses magnified. With the advent of ‘big bank’ in 1986 the UK regulator (now FSA) started interfering in the mechanics of how the London Stock Exchange operated but also in other areas such as the banking industry. Whilst reading the recent finance group, Cattles PLC statement I was appalled to discover that Cattles application for a retail banking licence was made to FSA and NOT the Bank of England. For many of us the Labour government’s antics with referring interest rate policy to the Bank of England has resulted in the ‘Old Lady’ failing in it’s role to police and supervise the UK banking industry. As “lender of last resort” there is clearly an impartial role here as senior bankers debate interest rate policy and try to appease the money market rates and forces of the market whilst supposedly acting as chaperone to UK banking. If the City of London’s credibility is to survive the overhang of recent events I believe that the UK government needs to return this interest rate process to HM Treasury immediately, strengthen the bank’s oversight role and investigate the actions of the London Stock Exchange for allowing a continuous repetitive backwardisation since 12noon till yesterday’s close whereby it was almost impossible for an orderly market in RBS’s shares to be conducted. A suspension of RBS’s listing should have prevailed but in fact only those with SETS (Stock Exchange Automated Trading System) access could deal preventing many investors from transacting business in the security. Notwithstanding this the extraordinary lack of transparency in bank balance sheets and off-balance has clearly torpedoed any attempts to stabilise the system since October last year.

The real problem that politicians, regulators, auditors and other practitioners need to address is that the derivatives tail globally is now estimated at US$600 trillion (£428 trillion @ 1.40). Assuming that UK businesses have say 10% exposure to this and conservatively control another 10% acting in their capacities as agents/advisors then the UK’s exposure to CDO’s, SIV’S and a host of other predominantly synthetic derivative instruments could be calculated at £86 trillion. Now it’s fair to say that not all these derivative positions are necessarily toxic but taking a conservative estimate of say 20% problematic, 50% possibly problematic then UK’s banking exposure could be somewhere in the £17 trillion to £43 trillion ball park (from now till 2025). Madness? Perhaps not! With RBS potentially putting £2 trillion transparently onto UK plc’s depleted balance sheet in the foreseeable future the likelihood is that if that happens and an orderly unwinding of RBS’s toxic positions took place alongside non-toxic assets (the sale of 4% stake of Bank of China was a typical fire sale valuation) then a liability to UK plc and tax-payers could easily accelerate to nearer £20 trillion of losses alone. Realistically massive banking write-offs need to happen hereon but the accounting mechanisms and laws governing insolvency are being severely tested and many believe as I do that these banks should enter into administration allowing for rump asset sales going forward (eg Coutts is a great brand within RBS; HSBC could off-load First Direct). The expected time-frame of offloading the government investment in banks such as RBS, Lloyds TSB, Northern Rock are totally unrealistic and UK shareholders do need to see that creditors and investors may actually retrieve a 1p or so per share rather than being absorbed into the UK plc p&l and balance sheet.

As at today the UK banking industry is on its knees and the resulting reaction to the level of £sterling internationally could be disastrous. Closer collaboration with ECB could again be disastrous as EU bankers struggle to cope with their own severe problems. More consolidation is likely but shouldn’t be encouraged for competitive reasons. In fact the reverse should happen and the sooner ABN can be restructured and hived-off from RBS the better; ditto National Westminster. What really needs to happen hereon in Europe (and there are those like myself who were saying this back in October) is that new stock banks are formulated asap with the backing of the central banks with green lights from the regulators. For regulators to hold up new banks and brokerage licences in the modern financial era is totally unacceptable. Good business plans with credible managements should be backed and supported by central bankers, the stock exchanges and the regulators immediately. I don’t think that LSE and FSA in London have any idea the damage their onerous application processes are having and in this regard I would expect Swiss banking to benefit from further backlashes in UK.

As I write Barack Obama is being inauguarated as 44th President and Lloyds TSB are languishing down -15 at 50p after a far from convincing discussion on Sky News last night between Sir Victor Blank, Chairman of Lloyds TSB and Jeff Randall, the City commentator. The outlook for Lloyds TSB is stretched indeed after the extraordinary acquisition of HBOS which surprised many in the City for its illogical and risky nature. The opportunities of a combined 30% share of the UK mortgage market looks ill-conceived to me as property ownership in UK comes full circle. Similarly arab investors are nursing terrible losses (as yet uncrystallised) in Barclays which may be in the sights of Standard Chartered who appear to better placed than any of their competitors including their main rival HSBC. Further cash calls, government aid, and insurance are more than likely but without new banks being allowed to pitch for a share of the UK market then the outlook looks horrendous for citizens and businesses. There are still some good names in banking left (Arbuthnot, C Hoare) and a host of names that could be rejuvenated and it is imperative that some modern competition is created asap. There are some great opportunities for corporate financiers if only the regulatory regime could fast-track new applications.

Hold tight for a rocky ride!

I continue to recommend that clients buy fixed income and precious metals rather than deposit balances in excess of £50,000 into UK banking system at present.