A group of midsize banks, including Metro Bank PLC and TSB Banking Group PLC, is preparing to lobby the Bank of England for a change in the rules on capital requirements for lending to let them compete with the big, established banks.
The smaller, newer banks are working with U.K. Finance, the banking and financial services trade group, on research into whether tighter capital requirements applied to newer, challenger banks compared with their longer-established rivals makes it harder for the newcomers to offer competitive lending rates, several industry sources, who declined to be named, confirmed. They intend to present the research, which is expected to show the rules favor established banks, to the Prudential Regulation Authority later in 2018.
Under Basel III rules, bank lending is regulated either on a standardized approach or an advanced or internal approach. The standardized approach requires banks to hold more capital against loans compared with the advanced approach which depends on banks using detailed data on customer loan defaults going back years to assess the capital requirements more precisely. The standardized approach is applied to new banks since they lack the detailed data which the incumbent big banks, including Lloyds Banking Group PLC, Barclays PLC and Royal Bank of Scotland Group PLC, already possess.
The difference in approach can result in huge disparities in capital requirements: the risk weighting assigned to a 50% loan-to-value residential mortgage is 35% under the standardized approach but can be less than a third of that for an established bank, said one executive at a midsize bank who declined to be named.
"For the big, high street banks which have data on loans gone bad going back decades, the risk weighting is 10% to 15% of the mortgage or less. But the newer banks might have a capital requirement of three times that and it is an enormous disparity," he said.
"The smaller banks are investing in producing models which can provide us with better data. We have to use data from the credit rating agencies for this so it's an expensive process and it takes a long time — the Prudential Regulation Authority takes about 18 months just to approve the model let alone the data it provides."
While regulations mean the rules on mortgage lending are different for the challenger banks the requirements for riskier lending, like commercial real estate loans, are virtually the same and demand the same level of capital from both kinds of banks.
"It is a peculiarity of the rules that because of the difference in capital requirements, there is now an incentive for smaller banks to take a little bit more risk by focusing on things like commercial real estate loans. We do not want to take more risk but the way the rules operate then that is what's happening," said the executive.
Following the financial crisis, a number of countries, including the U.K., encouraged the creation of challenger banks to take on long-established incumbents. However, tighter regulation was also introduced to rein-in careless lending.
Asked to comment on the study and the plans to present its findings to the regulator, U.K. Finance would say only: "U.K. Finance regularly consults its members on key issues facing the industry, including on how to ensure regulation is proportionate and promotes competition."