If There Was Only One Reason Why Firms Should Want to Commit to Robust RRPs, This Must Surely Be It…

By any measure, the costs of properly implementing a recovery and resolution plan (“RRP”) are significant.  Using the FSA’s own cost-benefit analysis conducted as part of Consultation Paper CP11/16, the costs to firms of preparing and maintaining a Recovery and Resolution Plan (excluding the costs associated with CASS Resolution Packs) over the next five years are:

  • High Impact Firms:  GBP 56,490,833
  • Medium High Impact Firms: 8,522,417
  • Medium Low and Low Impact Firms: 3,299,333

In light of this cost, it’s hardly surprising that some firms intend to do the minimum necessary to comply.  But are firms missing a trick in adopting this attitude?  There are many benefits to implementing a robust recovery and resolution planning regime, but the one most often overlooked relates to risk-weighted assets.

Once enacted, Basle III will require systemically important banks to have equity of at least 10% of risk-weighted assets (RWAs) plus credibly loss-absorbing debt.  However, some jurisdictions have gone further in “gold-plating” (or applying a “Swiss finish”) to regulatory capital requirements on their local banks.

The UK appears to be one such jurisdiction.  In September 2011, the Independent Commission on Banking (“ICB”) issued its final report, the conclusions of which were accepted in full by the UK government in December of that year.  The ICB has recommended that the retail and other activities of large UK banking groups should both have primary loss-absorbing capacity (i.e. regulatory capital and bail-in bonds) of at least 17%-20% of RWAs.

Within the 17%-20% range detailed above the ICB recommends applying regulatory discretion about the amount and type of loss-absorbing capacity.  In particular, the ICB has suggested that 3% extra equity capital might be required of a UK banking group that was judged “insufficiently resolvable to remove all risk to the public finances”.  In contrast, no additional equity capital might be needed for a bank with “strongly credible recovery and resolution plans”.

It would be simplistic to assume that the ICB’s recommendations would be applied in a binary fashion by the FSA, or its successor, the Prudential Regulation Authority (i.e. a 3% RWA penalty or no penalty at all with nothing in between).  Nonetheless, it is instructive to attempt to place an actual value on this 3% figure.  The table below is based on the 2010 financial statements of a number of major UK banks and building societies, and quantifies the annual amount of interest (assuming a rate of 50 basis points) that would be payable if an amount equal to 3% of RWA, being freed up as a result of having a robust recovery and resolution plan, were simply placed on overnight deposit.

 

Bank

Risk-Weighted Assets (GBP Million)1

3% of Risk Weighted Assets (GBP Million)

Overnight Interest (GBP Million)2

Barclays PLC

398,000

11,940

59.7

Clydesdale Bank plc

28,700

861

4.31

HSBC Bank plc

201,700

6,050

30.26

Lloyds Banking Group

406,400

12,190

60.96

Nationwide Building Society

50,100

1,500

7.52

Northern Rock Plc (now Virgin Money)

3,620

110

0.54

Principality Building Society

2,760

80

0.41

Royal Bank of Scotland plc

409,700

12,290

61.46

Santander UK plc

73,560

2,210

11.03

Standard Chartered Bank plc

155,150

4,650

23.27

Yorkshire Building Society

11,200

340

1.68

 

1 Where financial statements are reported in USD, the USD/GBP exchange rate as at 8 March 2012 has been used for comparison purposes

 2 Assuming an overnight interest rate of 0.5%

The potential dangers of false economy become clear – the opportunity cost of not implementing a robust recovery and resolution planning regime may quickly outweigh the marginal cost savings derived by doing just enough, but not more, to pass muster with the FSA.

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