Bank targets for shareholder returns are too high and do not reflect regulatory changes aimed at making banking a lower-risk, lower-return business since the financial crisis began in 2008, the Bank of England said Tuesday.
Britain's financial sector has been one of the hardest-hit in the world since the financial crisis began, and these remarks from the Bank's interim Financial Policy Committee highlight how the subsequent rethink of financial regulation in Britain looks set to produce one of the toughest approaches in the world.
Last week the FPC issued a series of recommendations for Britain's banks, including building up capital levels by cutting dividends and bonuses.
Tuesday's record of the November 23 meeting that led to these recommendations showed that the Bank accepted these measures might not be costless, though it did not elaborate.
Banks say they must offer competitive remuneration or see staff being poached by rivals and have even threatened to move operations elsewhere if pay curbs are too draconian. Banks also face renewed pressure Tuesday from investors to curb bonuses.
The FPC also had bad news for shareholders hoping for high profits from banks. One key measure of bank profitability had failed to change to reflect the tougher regulatory environment after the financial crisis, it said.
While return on equity objectives could have a legitimate role in communicating expectations to investors, current targets appeared to have not adjusted sufficiently to reflect the fact that new capital regulations should have made bank investments lower risk, but also inevitably lower return, the FPC said.
The 11-member committee added that it would return to the issue at future meetings.
In the run up to the financial crisis, bank chief executives routinely forecast ROEs of 25 to 30 percent, a level well above other major industries.
Banks have still been predicting ROEs in the high teens mirroring similar declines at global peers.
Royal Bank of Scotland
The interim FPC is chaired by Bank Governor Mervyn King, and issued its first recommendations in June. Currently it only has an advisory role, but new laws are expected to make it Britain's top financial regulation body from the start of 2013.
The record signalled that members of the committee are challenging the fundamental underpinnings of global bank capital rules known as the Basel III accord, which has just been toughened up in light of the financial crisis.
Last week, the FPC stressed the importance of continued bank lending to the real economy, and Tuesday's record showed that the committee was concerned that the Basel rules failed to encourage lending to businesses in tough times.
More broadly, the Basel rules focused on the effect of lending on individual banks in normal circumstances, and did not take into account the effect on the wider economy of, for example, lending to businesses versus capital to fund financial trading operations, the FPC said.
The Committee recognized that this line of thinking raised some major conceptual and practical considerations... and agreed that they should return to the issue.
They also expressed general concerns about banks' scope under the Basel system to use their own internal models to calculate their capital buffers.
Different banks could assign significantly different risk weights to identical portfolios of assets, the record said, suggesting some sort of backstop is needed to avoid some lenders holding too little capital against some assets -- which would be another departure from the Basel accord.
Some FPC members thought that... it would be appropriate to consider whether model-based calculations should be supplemented by minimum risk weights for specific categories of assets.
The European Banking Authority made a veiled criticism on Monday of Britain's push to move ahead of the Basel accord, saying it could worsen the euro zone debt crisis.
(Reporting by David Milliken and Huw Jones; Editing by Mike Nesbit)