Royal Bank of Scotland Group plc (RBS), Lloyds Banking Group PLC (LYG), Barclays PLC (BCS): Banks’ Capital: Now We Know the Worst

The Committee last week halved its estimate to 25 billion pounds. Banks have to raise that by the year-end, but around half is covered by initiatives already in train. So the real shortfall is a much lower 12 billion pounds.

It’s no surprise, then, that the report was greeted with a jump in the share prices of the three banks most affected, Royal Bank of Scotland Group plc (ADR) (NYSE:RBS), Lloyds Banking Group PLC (ADR) (NYSE:LYG), and Barclays PLC (ADR) (NYSE:BCS), though the turmoil in Cyprus left them overall down on the day.

The FPC has not revealed how the 12 billion-pound capital shortfall is split between individual banks, but the Financial Times says it includes 6 billion pounds for Royal Bank of Scotland Group plc (ADR) (NYSE:RBS), 3 billion pounds for Lloyds Banking Group PLC (ADR) (NYSE:LYG), and around 1 billion pounds for Barclays PLC (ADR) (NYSE:BCS).

Fudge

There’s some political expediency at play. Judging how much capital a bank needs is a subjective process, and the FPC chairman, Bank of England Governor Mervyn King, is a capital hawk. But the government said it wouldn’t put more equity into Royal Bank of Scotland Group plc (ADR) (NYSE:RBS) and Lloyds Banking Group PLC (ADR) (NYSE:LYG), so if the FPC had been too harsh, then both banks could have found themselves between a rock and a hard place.

Higher capital ratios also reduce banks’ ability to lend, with knock-on effects on the economy. With Mervyn King on his way out, policy is shifting toward the perceived greater emphasis on growth of his successor Mark Carney. Conveniently, the FPC lowered its yardstick for minimum capital Tier 1 ratios (after its judgemental adjustments) from 9% to 7%.

Some of the under-provided risks might remain, but the threat of banks being forced to raise dilutive equity has diminished.

Capital raising

Fundamentally there are three options to cover the shortfall: raise new capital, shed assets, or conserve cash.

Barclays PLC (ADR) (NYSE:BCS) is expected to make another issue of contingent capital bonds after its $3bn issue last year was five-times oversubscribed. The bonds pay a 7.6% coupon but get wiped out if the bank’s Tier 1 ratio drops below 7%. Royal Bank of Scotland Group plc (ADR) (NYSE:RBS) and Lloyds Banking Group PLC (ADR) (NYSE:LYG) might follow suit.

Royal Bank of Scotland Group plc (ADR) (NYSE:RBS) and Lloyds Banking Group PLC (ADR) (NYSE:LYG) are still shedding assets, but those initiatives are presumably included in the FPC’s assessment. RBS plans to make even bigger cuts in its investment bank to help meet the FPC’s shortfall.

RBS is also planning to partially float its U.S. retail bank Citizens. With the U.S. economy and its banks healthier than the U.K., a successful IPO could put some fire under RBS’s shares.