European Banks Face €280 Billion Capital Shortfall As Rules Bite Further In 2014 - PwC

Tom Burroughes

2 December 2013

Europe’s banks face a capital shortfall of around €280 billion ($380.8 billion) in 2014 due to the impact of tough new capital rules and other requirements, five years on from when global banking was hit by the 2008 credit crunch, according to .

The professional services firm said traditional methods of conserving capital will not “come close” to achieving what is needed so banks may have to issue up to €180 billion of new capital, a report issued today said.

“Between the requirements under Basel III and the Comprehensive Assessment, European banks are facing another turbulent couple of years,” Antony Eldridge, partner and financial services leader at PwC in Singapore, said in a statement.

“Although the environment for capital raising is becoming more favourable, €180 billion is still a lot for the market to absorb in the short term. So the competition for new capital will be fierce,” he said.

“Although regulators will likely give banks some breathing space to execute their plans, the markets will apply more urgent pressure and this will drive banks to continue with their urgent de-leverage programmes. But we expect 2014 to mark a big shift of emphasis, from de-leverage on the asset side – disposal and de-risking of assets – to de-leverage on the liability side – capital raising and restructuring. We call this ‘de-leverage take 2’,” he continued.

“This will be a dramatic shift, arising from a combination of necessity, good sense and opportunity. Necessity, because the regulatory intent is clear and banks are running out of road on the asset side. Good sense, because with capital costs falling, and the prospect of underlying economic growth returning, there is a compelling case for banks to bring new equity on board. Opportunity, because the gradual recovery in bank valuations suggests there is growing investor appetite to provide it,” Eldridge said.

The 2008 financial crisis, and the bailout of several banks by taxpayers in different countries, exposed how some financial institutions were vulnerable to high leverage and inadequate capital reserves. A problem in the immediate aftermath of the crisis has been the ability to reconcile the competing requirements from policymakers that banks start to lend again to revive economies on the one hand, and restore banks’ balance sheets, on the other.

Other findings from the report, De-leverage take 2, include:

-- The leverage ratio will become the de-facto determinant of regulatory capital for many banks and will ratchet up the industry-wide shortfall in regulatory capital above and beyond that dictated by risk-based capital requirements;

-- In the eurozone, just as capital demands are being pushed up by Basel III (including the leverage ratio), there is every likelihood that the ECB Comprehensive Assessment will further exacerbate the capital shortfall;

-- There will be short term disruptions and adjustment costs, but concerns about economic viability under the additional regulatory capital load are unfounded;

-- Reduced asset risk and reduced leverage are bringing down the cost of bank equity and this trend will continue. This applies to business lines as well as whole banks, so they should think twice before pulling out of capital intensive but otherwise profitable lines.

-- Capital raising will take a variety of forms, including internal capital restructuring, organic earnings retention, rights issues, alternative capital instruments such as Cocos, and minority stakes in special purpose vehicles. There is also likely to be a resurgence of securitizations.