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Look Ma, no capital
Apr 24th 2008
From The Economist print edition


Racy balance-sheets looked great in the go-go years, but not any more

GENERALS stand accused of lacking foresight, inclined as many of them are to be preparing to fight the last war. What then of bankers, who show little sign even of hindsight? Most seem unable to grasp the lessons of the last crisis, still less to anticipate the next one.

Take Royal Bank of Scotland (RBS), Britain's second-largest bank, which in February merrily increased its dividends to shareholders despite ample warning that the worst of the global credit crunch was yet to arrive. Sir Fred Goodwin, the bank's well-regarded chief executive, confidently told investors that he had “no plans for any inorganic capital raisings or anything of the sort”.

After hubris comes the fall. On April 22nd Sir Fred went cap in hand to shareholders, asking them for £12 billion ($24 billion) in Europe's largest capital-raising to date. He says he may also have to pawn some family silver: he hopes to raise another £4 billion by selling the bank's profitable insurance business.

The cash is needed to rebuild RBS's balance-sheet, which has been strained by fresh write-downs totalling £5.9 billion on its investments in iffy American mortgage loans as well as by its badly timed purchase last year of a large part of ABN Amro, a Dutch bank. The volte-face prompted several large shareholders in RBS to call for Sir Fred's head. He has hung on to his job for now, but his days at the bank look numbered.

At issue is RBS's “core capital”, a cushion composed mainly of shareholders' equity that regulators insist banks hold against bad times. At the beginning of the year this stood at about 4.5%, the lowest of any big European bank and below the 5-6% level that most banks consider a prudent minimum.


Other big British banks are also sitting on a flatter capital cushion than their rivals in other parts of the world. Analysts at JP Morgan, an investment bank, reckon that British banks should be holding around £37 billion more in capital than they do at the moment.

Among banks that have capital concerns are Barclays and HBOS, which JP Morgan reckons will need £8 billion and £11 billion respectively. Barclays, whose securities business made profits in the first quarter of 2008, may prefer to retain earnings rather than raise fresh cash. But investors' worries about capital adequacy are showing up in share prices. Banks such as flush HSBC and solid Lloyds TSB, which have more capital, have performed far better this year than those that are short of it (see chart).

In good times a racy attitude to capital has helped to make British banks among the most profitable, with enviable returns on equity. In tougher times, however, they look too clever by half.

http://www.economist.com/world/britain/PrinterFriendly.cfm?story_id=11090735