All five major UK banks recorded a profit in the first half of the year, for the first time since 2010 according to KPMG. Combined profits of some £16.5bn, modest lending growth and falling impairments all show that the banking sector is, at last, starting to get back on track after the financial crisis. However, the industry emerging is very different to how it was before the crisis started and is adjusting to a future in which, KPMG says, bank business models are “unlikely ever to be the same again”.
KPMG’s Bank Performance Benchmarking Report explores the key trends in the first half results of the big five UK headquartered banks – Barclays, HSBC, Lloyds Banking Group, RBS and Standard Chartered – and warns that, despite this better performance, real threats and uncertainties remain.
Improved picture marred by ongoing fines and mis-selling costs
Whilst overall lending was up – including mortgage lending up by 0.8% or £5 billion – and customer deposits grew by 6% or £135 billion during the period, Return on Equity (ROE) remains in single digits. ROE has roughly halved compared to 2005 levels, from near 20% to under 10% now – and this looks unlikely to reverse in the near-term. This is accentuated by the fact that average capital ratios have increased from 11.4% to 12%. Banks are safer but much less profitable per shareholder £.
Approaching 20% of first half statutory profits were wiped out by the continuing need to set money aside against PPI claims (£2.3bn) and interest rate hedging products (£700 million). The need to make cost and efficiency savings is also restraining performance, with £1.9bn spent on integration and restructuring costs in H1 2013. Over the last two and a half years, the total costs of remediation and litigation amongst the top five banks equates to 45% of total profit before tax.
Bill Michael, EMA Head of Financial Services at KPMG, said: “While it is great that the most recent bank results are in the black, there remains real uncertainty on the shape of their business models in the future. We have reached an inflection point. Capital requirements are going to put huge pressure on banks to deleverage. The fear is that we will end up with a UK banking sector with very narrow choice, where individuals will not be able to get the products they need. We have to get the balance right between prudence and growth.”
Too much change, too soon?
KPMG’s report also warns of other more systemic threats than the familiar mis-selling issues:
Regulatory change: waves of regulatory change, both local and global, appear to be pushing some countries – and the global financial system – beyond the ‘tipping point’ at which the negative impact of regulation on economic growth begins to exceed its benefits
Speed of reform: the regulatory problem has been exacerbated by the speed at which changes are being implemented. The result of regulators’ actions is that banks are enhancing their capital ratios far ahead of the regulatory timetable to meet market expectations
Changing leaderships: these changes are coming at a time when a new group of leaders is at the helm of UK banks. At the same time, between 2006 and 2012 more than 75% of non-executive directors and 72% of executive management have been replaced at the five major UK banks. There is a risk that boards and senior management are forced to become short-termist and risk averse, focused on their institution’s (and indeed their own) immediate safety and survival, rather than looking for a sustainable route back to growth. Regulators need to help them execute this challenging agenda, KPMG says
Local and domestic
KPMG’s report also notes that there has been a move towards a more local and domestic emphasis amongst UK banks. Barclays is now the only UK bank in the investment banking top ten. The trend appears to be for a smaller, more ‘vanilla’ sector, but if so it will be one less able to compete with a resurgent Wall Street. There has been an increasing localisation of banking markets as different jurisdictions impose their own capital, liquidity, governance and structural requirements in the scramble for greater control over what happens on home turf. This fragmentation, the report warns, will severely constrain international banks’ ability to provide financial services effectively to their international corporate customers. Indeed, it begs the question: is it possible to run a truly international bank anymore?
Systemic shocks – still fighting the last war?
There has been a surge of initiatives and reforms to guard against another banking crisis caused by such factors as another liquidity crunch or inherent capital weakness. But, KPMG’s report asks, are we still fighting the last war? The next systemic shock, if there is one, could come from an as yet unforeseen event such as a massive systems outage or a new breed of cyber attack. After years of improvement, UK banks suffered a 12% increase in online account fraud last year. Furthermore, the motivation for cyber assaults is shifting, from financial crime to political and ideological attacks, with the number of state-sponsored hacking and ‘hacktivist’ revenge incidents growing. Six major US banking institutions suffered website outages in 2012. Their UK counterparts have escaped similar mass disruption assaults so far – but they remain under pressure to ensure their critical systems are robust enough to cope with a failure.
Bill Michael concluded: “Clearly we are witnessing a sector that is going through rehabilitation. The banks are working very hard to change what they do and how they do it. Only when they are fully rehabilitated will they get full access to the top table of economic discussion and debate – and only then will there be a fully coherent strategy for banking and economic growth. In the meantime, the future is looking a little brighter for the banks, but is still heavily tinged with uncertainties and threats. Not least of these remains the Eurozone, despite the major lift in bank share prices from the actions of the ECB in defending the euro.”
