London Scottish short on capital

Basel II could see some firms short on capital reserves following credit crunch

LONDON – The UK banking industry received a New Year’s Eve shock when specialist finance firm London Scottish Bank (LSB) announced it had been ordered by the Financial Services Authority (FSA) to raise £13 million in regulatory capital reserves.

Shares in the lender – which has 220,000 UK customers and over 2,000 staff – plunged after it became clear the shortfall in the bank’s Basel II regulatory capital requirements was caused by losses in its unsecured credit division caused by customer defaults.

LSB says it is considering scrapping its dividend and launching an emergency rights issue.

The Bank of England warns that the adoption of the Basel II risk-based capital rules, which came into force from January 1, has left the banking industry increasingly at the mercy of the credit rating agencies, and vulnerable to cyclical booms and busts.

"The FSA's warning to London Scottish Bank on the day Basel II came into force on January 1 is a stark warning to the banking industry that it must take a responsible approach and will need to do more to comply with the spirit and intent of regulation, as opposed to doing the minimum that will allow the avoidance of closer regulatory scrutiny," says Roger Martini-Facio, Head of Risk and Compliance at LogicaCMG UK. "Prudent management of risk across the board, supported by realistic stress testing will provide competitive advantage if a bank can use it to manage the inherent volatility of its businesses over time.

"The Basel II regulations already provide a basis for a systematic approach to risk. Banks should now look more carefully at the principles of Basel II, and on that basis develop methodologies to build more effective processes that will allow the means to more accurately measure and manage risk, not just credit, operational and market risk, but also those areas that are not yet fully defined within the regulations, such as liquidity risk. As data models become more sophisticated and the data gathering and manipulation to support them becomes more systematic, banks will increasingly be able to look deeper into the aspect of correlations between risks."

The FSA recently punished a number of other British lenders for selling customers unaffordable subprime-type loans.