Read our analysis of the impact of Basel III elsewhere in the world.
The UK and Basel III
With its reliance on the financial sector, the UK intends to accelerate the adoption of Basel III rules. While British banks have significantly improved their capital and liquidity positions over the past two years, the Financial Services Authority has urged banks to not wait for implementation of Basel III to meet the higher standards. Recent recommendations from the Independent Banking Commission suggest regulatory changes are not going to be as great as the market feared but will still have built in higher-than-Basel standards. For instance, the commission recommends separately capitalising retail and investment banking within a parent and that the retail bank must maintain 10% common equity--3% more than Basel III rules.
The Royal Bank of Scotland (RBS) is 84% owned by the British government. The bank is on a plan that requires it to sell multiple businesses regardless of the price it receives for them; however, this should free up some capital and improve its liquidity position. RBS' plans call for a core Tier 1 ratio of over 8% under Basel III rules by 2013. As of Dec. 31, its core Tier 1 under Basel II was 10.7%. Even though the firm is on its way to meet its targets, we think that it is not out of the woods yet and that noncore losses will continue to deal heavy blows to profits attributable to shareholders.
Lloyds Banking Group (LLOY) is the second British bank that we cover that owes its survival to government aid. Lloyds nearly destroyed itself in 2008 with its ill-considered acquisition of HBOS. The 2008 government-sponsored capital raise ended with the UK government owning 43.5% of the combined Lloyds-HBOS entity. In November2009, Lloyds announced a plan that would allow it to leave the UK's expensive Asset Protection Scheme that it is currently trying to execute. In our opinion, Lloyds seems to have a good foothold in regard to its capital position. As of Dec. 31, the firm's core Tier 1 capital ratio stood at 10.2%.
Barclays' (BARC) core Tier 1 ratio was healthy at 10.8% at the end of 2010. Management maintains that it is confident in the bank's ability to tackle the new regulatory measures, especially since it expects to meet its 13% ROE target. We think this profitability level should allow the bank to organically grow its capital base to the necessary minima without necessitating a significant amount of new equity, if at all.
Standard Chartered (STAN) closed 2010 with core Tier 1 and Tier 1 capital ratios of 11.8% and 14.0%, respectively (versus 8.9% and 11.5% in 2009) after a surprise late 2010 equity raise. Combining its current capital base with its strong internal equity generation power, the bank will face no major issues in complying with new regulatory standards, in our opinion.
HSBC's (HSBA) core Tier 1 capital currently stands at 10.5%. The company estimated that Basel III rules would reduce its core Tier 1 by 250-300 basis points, putting it at 7.5% at the low end--already compliant with the 2019 requirements. However, HSBC would probably be subject to any additional scrutiny and capital requirements of a systemically important entity. Management estimates its common equity Tier 1 capital would need to be between 9.5% and 10.5% under the new rules, requiring the bank to continue expanding its current capital base over the next eight years.
Morningstar Institutional Equity Research Services
Independent. Actionable. Rigorous.
Insightful investment ideas.
With nearly 100 equity and credit analysts, Morningstar is one of the largest independent sources for equity and credit research in the world. Our analysts evaluate companies using a proprietary methodology built on fundamental analysis that scrutinises a company’s sustainable competitive advantages. The strong performance of our ratings speaks for itself: The Morningstar® Wide Moat Focus Index has returned an annualised 14.94% since its inception in September 2002. This index tracks 20 stocks with a Wide Economic Moat™ Rating trading at the most significant discounts to our Fair Value Estimates.
