PwC: European banks face capital shortfall of c. €280bn

  • European banks are facing another turbulent couple of years
  • PwC estimates that new equity of up to €180bn will be called for and expects a resurgence of the securitisation market
  • Recovering bank valuations suggests growing investor appetite

Singapore, 2 December 2013 – A new report from PwC says 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 €280bn.

Traditional capital mitigation responses will not come close to closing this gap. PwC estimates that new equity of up to €180bn will be called for.

Antony Eldridge, Partner and Financial Services Leader at PwC Singapore said:

“Between the requirements under Basel III and the Comprehensive Assessment, European banks are facing another turbulent couple of years.

“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’.

“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.

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 l ikelihood 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. Pulling out due to capital constraints leaves money on the table.
  • 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 (SPVs). There is also likely to be a resurgence of securitizations.

Antony Eldridge, Partner and Financial Services Leader at PwC Singapore continued:

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

 “For banks which fall under the ECB Comprehensive Assessment, even though the process will not conclude until late 2014, they should not defer action until then. Taking action sooner rather than later could mitigate the risk of market disruption or volatility at that time and avoid the need to resort to national back-stops. And banks outside the ECB’s scope who nonetheless need to raise capital should also take their opportunities while they can. There are potential competitive advantages in going early, and downstream scenarios from leaving it until later that are worth avoiding.

“Given the size of the gap, and the potential bottle-neck in the supply of fresh ordinary equity, there will also be intense pressure to innovate with new capital structures and strategies. Overcoming the frictions associated with internally ‘trapped’ capital will be a big focus, and we expect a resurgence of the securitisation market. We also see potential for the creation of SPVs with specialist minority equity participation as a means to broaden and deepen the investor base and improve overall consolidated balance sheet ratios. There are both economic and public policy grounds to make that work.

“As ever with major regulatory changes it will be painful, but in this case the pain will be in the transition rather than in the end state. And for some there is even a chance to take a less painful path, make a virtue of necessity, and stock up with capital.”

End


Media Contact
Candy Li, PwC LLP Singapore (Tel: +65 6236 7429 Email: candy.yt.li@sg.pwc.com or pwcpress.sg@sg.pwc.com)