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Rates of change

19 May 2020 By Liam Proud

British central bankers seem more positive about negative rates. That’s worrying for the country’s lenders, especially so-called challenger banks like Virgin Money and Metro Bank. The likely upshot of such a move would be a rollup of smaller players.

The Bank of England is looking “with somewhat greater immediacy” at the prospect of taking interest rates below zero, Chief Economist Andy Haldane said in a Daily Telegraph interview. That would mean charging lenders for any money they keep at the central bank beyond their regulatory requirements, in theory incentivising them to lend.

Banks’ margins would suffer – like in the euro zone, which went negative in 2014. UK lenders’ net interest income in 2019 was equivalent to 1.96% of average interest-earning assets, UBS data shows. Assume, conservatively, that falls to 1.8% – still much higher than the euro zone’s 1.63%. UK banks’ interest income would be 8% lower, bringing total revenue down 5%. Assuming costs stay flat, operating profit before bad debt would fall by 11%.

Bigger lenders may fare better. Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland on average generate three-fifths of revenue from interest income, using the median 2020 analyst estimate gathered by Refinitiv. The rest comes from investment banking, wealth management and other fee-based products.

That’s much lower than the average 88% proportion at upstarts OneSavings Bank, Paragon Banking Group, Virgin and Metro. Their dependence on lending means that an 8% interest income decline would pull total revenue down by 7.3%, compared with a more modest 5% at the big banks. Virgin and Metro have the added vulnerability of low profitability: the pandemic fallout will see their respective returns on tangible equity fall to 2% and minus 10% this year, using the Refinitiv median analyst estimate.

Selling to a bigger peer like Lloyds or Banco Santander would make sense. Alternatively, the healthier challengers, such as OneSavings, could snap up the stragglers. Cost synergies would be large: when CYBG and Virgin decided to merge in 2018, estimated annual savings of 120 million pounds were 44% of the latter’s operating profit. Regulators might look favourably on a more profitable and stable combined bank. Chief supervisor Sam Woods said in January that he wouldn’t necessarily be hostile to consolidation. Besides, he could hardly complain if it came about because of his own employer’s unconventional interest-rate policy.


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