29 November 2013

PwC: De-leverage take 2 - Making a virtue of necessity

The recent exchange of letters between Chancellor George Osborne and the Bank of England Governor Mark Carney (links) has put the spotlight firmly on the issue of leverage. A new report from Miles Kennedy looks at tackling the issue of de-leveraging.

The report, "De-leverage take 2", finds that European banks face a substantial capital crunch in 2014 through the combined impact of Basel III capital ratio requirements, leverage ratio requirements, the ECB Comprehensive Assessment, and possible further national regulatory developments. PwC estimates that total capital shortfalls in Europe will be in the vicinity of €280 billion.

Traditional capital "mitigation" responses will not come close to closing this gap. It is estimated that new equity of up to 2/3 of that shortfall (ca €180 billion) will be needed. As economies rebuild banks should switch from asset contraction to capital expansion. Although the environment for raising capital is becoming more favourable, €180 billion is a lot for the market to absorb in the short term so the competition for new capital will be fierce, so banks in need of capital should take heed.

While "De-leverage take 1" was all about asset contraction, "De-leverage take 2" explains that the emphasis needs to shift to capital expansion.

“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”, said PwC’s Miles Kennedy. “This will be a dramatic shift, arising from a combination of necessity, good sense and opportunity."

On top of that, Kennedy fears the European Central Bank’s wide-ranging assessment of banks’ asset quality and capital positions will find the gap is even larger. Although the changes may be painful in the short term, PwC expects it will create a stronger system with a level playing field between banks across the EU. “These challenges, frictions, market distortions and competitive biases are only short term phenomena, resulting from the legacy of an over-levered banking industry", the report argues.

“There is a chance to take a somewhat less painful path: with economic confidence gradually returning and investors more or less reconciled to the reality of a less levered bank sector, there is a chance for banks to make a virtue of necessity and restructure their capital.”

Press release

Full report (registration required)

Further reporting © CityAM

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