Barclays Bank: Well Capitalized But Banking Reform Is A RiskRupert Hargreaves
UK-based bank Barclays Plc has been trying to transform itself over the past decade into a transatlantic investment bank, although the payoff from this transformation has yet to materialize.
Substantial charges in respect of legacy conduct issues and litigation have weighed on the bank's profitability in recent years, specifically, provisions for customer redress for payment protection insurance, which have cost an estimated £9.2 billion so far and the potential for further costs makes it difficult to predict Barclays' outlook over the next 18 months.
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That being said, even though it is struggling in some areas, Barclays is one of the most well-capitalized banks in Europe. It reported a common equity tier 1 capital ratio of 13.3% at the end of December, in line with the median of its global peer group while it's tier 1 leverage ratio for the same period was 4.5%, below the 5.2% median for global peers.
Still, according to credit rating agency Moody's, when it comes to capital adequacy investors' should not be concerned about Barclays' solvency. According to a recent credit note on the company, Moody's analysts note:
“We expect Barclays' capitalisation to continue to improve over the next 12-18 months as a result of (1) a further reduction in its legacy assets; (2) achievement of full regulatory deconsolidation of Barclays Africa Group Limited (LT senior unsecured programme rating (P)Ba1), following the stake reduction in H1 17, which should lead to a further increase of around c.10 basis points (bps) in its CET1 ratio; and (3) its retained profit and management has highlighted that it may temporarily run above the end-state whilst it addresses legacy litigation and conduct matters.”
The credit report goes on to say that at the end of December 2017, Barclays had a sizable retail and corporate deposit book of £429 billion, well more than its loan book. Moody's calculates the gross loan-to-deposit ratio is 85%.
Previously, analysts have speculated that one of the most significant risks facing the bank is the unpredictability of earnings from its investment banking and capital markets business, which are the most significant contributors to group risk-weighted assets and come with considerable tail risks (considering £527 billion of financial assets and derivatives at the end of December).
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As the company separates itself under UK ring-fencing plans, which require banks to legally separate retail facing and investment banking divisions, its financing requirements will change. When the ring-fencing is complete (before the end of the decade), 20% of risk-weighted assets will fall in the retail bank, with 80% falling in the global investment bank, but the bulk of deposits will falling into the retail bank, potentially making it harder to obtain financing at favorable rates.
Management has been proactive in reducing risk here, accumulating a liquidity pool of £220 billion at the end of December, which is “well more than the stock of short-term wholesale funding, and most of the liquidity buffer qualified as high-quality liquid assets as of the same reporting date.”
That's not to say that the bank will not face any ring-fencing issues over the next 18 months. In fact, until the action is complete, Moody's is taking a cautious view of the company ahead of any substantial negative changes to the capital structure:
“Barclays Bank will become a non-ring-fenced bank and will account for the remaining around 80% of group RWA. Barclays Bank will thus become more reliant on corporate banking and capital market activities, despite maintaining certain activities, such as international cards, private banking, and payments. Therefore, we believe that earnings volatility will increase for Barclays Bank and that the bank will also be more reliant on confidence-sensitive wholesale funding, weakening its standalone credit assessment. We have, therefore, assessed that the existing creditors of Barclays Bank will face higher expected losses than they currently do following the implementation of ring-fencing.”