THE behaviour of the big UK banks will be among the most important factors determining the strength or otherwise of the country’s economic recovery in coming months and years from the devastating blow of the coronavirus pandemic.
So far, there has been a distinct lack of controversy over the banks’ behaviour, amid massive state support measures put in place to help households and businesses deal with the unprecedented economic shock of the pandemic.
Much has been in suspended animation, or in the deep freeze.
The banking situation so far has contrasted starkly with the enormous misery of the huge credit crunch which hammered so many businesses and households during and in the wake of the global financial crisis that blew up more than a decade ago and had such grimly protracted effects.
The real test of the big banks’ behaviour this time round will come when the massive government support measures, on myriad fronts, unwind.
Of course, the UK Government in particular, with its big tax-raising and spending powers, has a duty to unwind the measures in a sensible way, extending support where this is required until normality returns, particularly for employees and businesses in sectors hit hardest by the pandemic. In this regard, Chancellor Rishi Sunak’s continuing plans to end the coronavirus job retention scheme in September are still ringing a very loud alarm bell.
However, the banks will also have a huge part to play.
The banks have been under the state spotlight since the onset of the pandemic, notably in terms of dividends. As the crisis took hold in spring 2020, a “request” by the Bank of England’s Prudential Regulation Authority for the big UK banks to suspend dividends and share buybacks marked a very major move.
On March 31 last year, the regulatory authority said: “The PRA welcomes the decisions by the boards of the large UK banks to suspend dividends and buybacks on ordinary shares until the end of 2020, and to cancel payments of any outstanding 2019 dividends in response to a request from us. The PRA also expects banks not to pay any cash bonuses to senior staff, including all material risk takers, and is confident that bank boards are already considering and will take any appropriate further actions with regard to the accrual, payment and vesting of variable remuneration over coming months.”
The PRA characterised its actions on this front as “a sensible precautionary step given the unique role that banks need to play in supporting the wider economy through a period of economic disruption, alongside the extraordinary measures being taken by the authorities”.
Reflecting on these moves, on December 10 last year, the PRA highlighted the importance of the steps taken in spring 2020 in reducing the possibility of “an unsafe depletion of banks’ capital”.
It said: “At the end of March 2020, the Prudential Regulation Authority…welcomed the decisions of the boards of the large UK banks to suspend dividends and buybacks on ordinary shares until the end of 2020. At the PRA’s request they also cancelled payments of any outstanding 2019 dividends and restricted cash bonus payments to senior staff.
“This exceptional request reflected the unprecedented levels of economic uncertainty facing the global economy at that time due to the onset of the Covid-19 pandemic. The initial global spread of Covid-19 occurred at a moment late in banks’ dividend calendars when dividend distributions they had announced were about to be paid out. Given this timing, the then existing market conditions, the very large and uncertain size of the forthcoming downturn, and the unique role that banks play in supporting the wider economy, the PRA’s request was a necessary precautionary step in order to reduce the possibility of an unsafe depletion of banks’ capital in the face of a risk of unknown dimensions.”
Last December, the PRA declared that it judged “that an extension of the exceptional and precautionary action taken in March is not necessary and that there is scope for banks to recommence some distributions should their boards choose to do so, within an appropriately prudent framework”.
And it outlined a move to a “framework of temporary guardrails” for bank boards when making decisions on 2020 distributions.
Crucially, in this context, it highlighted the “need for banks to continue to support households and businesses through the continuing economic disruption, even in the event that this disruption is more prolonged and severe than currently anticipated”.
The PRA also declared it expected “firms to exercise a high degree of caution and prudence in determining the size of any cash bonuses granted to senior staff given the uncertain outlook and the need for banks to deploy capital to support the wider economy”.
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The point about the importance of banks deploying capital to support the broader economy is a crucial one. It is in many ways an obvious observation and a simple reality but, if anyone is in any doubt about it, a reflection on what occurred amid and in the wake of the global financial crisis should provide plenty of confirmation.
The PRA made another big decision last week on bank dividends, removing with immediate effect the “extraordinary guardrails” it had put in place. In doing so, it flagged a significant fall in uncertainty since December 2020, and the important part played on this front by Covid-19 vaccination progress.
It said: “Taking into account the interim results of the 2021 SST (solvency stress test), the PRA judges that banks remain well capitalised and resilient to outcomes for the economy that are much more severe than the Monetary Policy Committee’s central forecast, and that they should therefore be able to support households and businesses through the economic recovery. In addition, although considerable uncertainty remains, the level of uncertainty has decreased significantly since December 2020, in particular due to the progress of vaccination programmes.
“The PRA has therefore concluded that the extraordinary guardrails within which it asked bank boards to determine the appropriate level of distributions in relation to full-year 2020 results are no longer necessary and have been removed with immediate effect.”
This is a relatively encouraging assessment of the strength of banks, and of the developing backdrop.
However, no one should be in any doubt about the scale of the challenges ahead, and it was good to see the PRA emphasise that it is “essential” that banks continue to support households and businesses.
Giving an overview of the new arrangements, with the removal of the “guardrails”, the PRA said: “Under this framework, bank boards are responsible for making distribution decisions subject to the standard constraints of the regulatory framework, including the regular annual stress test. The full and final results of the 2021 SST, including bank-specific outcomes, will be published in 2021 Q4.”
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It added: “In the meantime, it is essential that banks continue to support households and businesses through the economic recovery and as the Government’s support measures unwind over the coming months, including in the event that economic outcomes are more severe than currently expected. Bank boards should therefore continue to exercise an appropriate degree of caution around the level of any shareholder distributions.”
Decisions on dividends have clearly been put firmly back in the hands of bank boards, and it will be interesting to see what transpires.
The banking sector’s reputation took a hammering, for understandable reasons, during the global financial crisis and in the years that followed.
Insolvency experts have noted the banks’ behaviour so far in the current crisis has played a key role in keeping the number of business failures low. This behaviour has obviously been enabled by the huge state measures to support businesses and households.
There is an expectation that company insolvencies will rise as support measures are unwound but a difference of opinion among experts on how sharply they will rise.
It is crucial for policy-makers to realise that the real test of banks’ behaviour lies ahead. And that this behaviour, whether good, bad or indifferent, will be a key determinant of where we go from here. In short, how banks behave will dictate whether or not many struggling businesses and households sink or swim on the difficult journey back to firm ground from the tumult of the pandemic.
The PRA’s assessment shows that banks are well placed to support businesses and households.
The big question is whether the banks will continue to do so in the way they have so far in this crisis as support measures unwind, and with the “guardrails” for dividend payments having been removed.
A patient approach from the banks would surely go a long way to minimising their bad debts over the longer term, as well as crucially supporting the broader economic recovery.
However, we live in a world of short-termism, so everyone will need to keep a very close eye on how things develop.
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