In an effort to stimulate lending the Financial Services Authority (FSA) has eased capital and liquidity rules for the biggest UK banks. The FSA informed banks that they will not be required to hold any extra capital against new UK loans they make that qualify for a ‘funding for lending’ loan. This effectively allows UK-domiciled banks such as Royal Bank of Scotland, Lloyds and HSBC and UK subsidiaries such as Santander UK to consider the new lending as risk-free for regulatory purposes. This effectively side-steps recent regulations imposed by the Basel III agreement.
London regulators have stepped back from tough overall capital rules they imposed after the Basel III reform package was adopted. Basel III is the global framework governing the regulation of bank capital, liquidity and leverage in the wake of the world financial crisis. Under Basel III banks are encouraged to hold more capital and therefore lend to fewer high-risk ventures. Lending to SMEs is weighted as relatively high risk, a policy inherited from Basel II, and should, when combined with rising capital requirements and turbulent capital markets, result in a disproportionately high cost of capital for banks when lending to such businesses and a gradual shift of their entire business models away from SME lending. Unfortunately this is the antithesis of what SMEs need to grow and expand. Due to the relaxation by regulators UK banks will not be required to achieve and maintain a core ratio equal to 10 per cent of their assets.
Instead of a percentage objective, individual UK banks have been set numerical targets for capital and have been told their ratio can drop below 10 per cent in the meantime. The absolute number means banks cannot meet regulatory targets by cutting lending and the flexibility on the ratio gives them room to expand lending as demand grows. The FSA’s move has put the UK at the forefront of what is called “macro-prudential” oversight in which regulators consider not just whether individual banks are sound but also broader economic and stability concerns. From next year, the combination will become official as the Bank of England runs monetary policy, supervises banks and promotes financial stability.
This move is designed to dodge a severe double-dip recession and making sure that regulation is not choking off the flow of capital to the real UK economy. This has been one of the main arguments against Basel III particularly when considering small and medium sized enterprise funding. This area of finance struggles due to high costs of servicing, as it takes the same amount of time and money to vet a £100 million loan as it does a £1 million loan. With Basel III, SMEs attract a higher capital charge meaning that when a bank becomes stressed, SMEs are often the first to see their loans pulled.
The eased requirements are a beneficial rebalancing for both banks and customers. With movements by the Government to improve credit provision in the form of Funding for Lending and the British Business Bank, as well the relaxation of regulations by the FSA banks have no excuse to not support small businesses. Banks can increase their resilience to market fluctuations and still support lending if they take the right steps to remove bad loans and non-core assets from their balance sheets. We must continue to encourage banks to improve their credit provision practices and, working within the constraints of existing accounting practices, to value their assets sensibly.
The good news is that if traditional opportunities for working capital are still hard to acquire there are alternative ways to secure business funding. There are now relatively young tech-finance companies that offer options for every stage of the business lifecycle, from new entrants to the banking market, to crowd-sourced equity providers, peer-to-peer lending, as well MarketInvoice’s own model of online invoice finance.