Relief for credit losses buoys Barclays’ capital ratio

Barclays saw its capital position strengthen over the three months to end-June after benefiting from emergency regulatory interventions that eased the burden of the coronavirus crisis on the banking system.

The bank’s ratio of Common Equity Tier 1 (CET1) capital to risk-weighted assets (RWAs) hit 14.2% in Q2, up from 13.1% in Q1. Of the net 110 basis points increase, 45bp were directly attributable to relief measures. 

New rules introduced in March allowing banks to negate the the capital-sapping effects of expected credit loss (ECL) provisions on souring loans contributed 35bp to Barclays’ ratio improvement, and amendments to the calculation of its prudent valuation adjustment (PVA) an additional 10bp.

 

In Q2, the bank took £1.6 billion ($2.1 billion) of ECL provisions, equal to 1.79% of outstanding loans.

The CET1 ratio also benefited from a net £6.6 billion of RWA reductions quarter-on-quarter. Some of this reduction was attributable to changes in market RWAs, which fell £2.7 billion over the quarter, in part because of relief granted by the Prudential Regulation Authority that stopped value-at-risk backtesting exceptions adding to the total.

Barclays generated 60bp of capital through profits over Q2, which more than offset a -51bp hit from credit impairment charges linked to past-due loans.

Who said what

“Our plan for running the businesses do currently assume some further procyclical effects materialise in H2 ... Overall, I would expect the RWA flight path to be a headwind to the capital ratio in H2. The other headwind I’d call out is the potential capital effect of the H2 impairment charge to the extent it has an increased element generated by defaulted balances, which should not be eligible for the increased transitional release that benefited the Q2 ratio,” – Tushar Morzaria, group finance director at Barclays.

What is it?

Under IFRS 9 accounting rules, banks’ ECL provisions are calculated using forward-looking scenarios for GDP growth, unemployment, inflation and short-term interest rates, among other economic indicators.

Provisions are calculated differently depending on the credit quality of the relevant assets. Stage one assets have suffered no breakdown in credit quality; stage two have experienced a big drop in credit quality; and stage three have actually become impaired. Assets in the first group need to be backed by enough reserves to cover 12 months of ECLs. Those in the other two must be provisioned for ECLs over their entire lifetime. ECL provisions divert earnings from shareholder equity, diminishing a bank’s supply of CET1. 

In March, the Bank of England, in concert with other financial regulators, allowed banks to ‘add back’ 100% of stage one and two IFRS 9 provisions incurred since January 1 into their regulatory capital to reduce pressure on their core solvency ratios through the Covid-19 pandemic. The temporary measures apply to end-2021. 

Provisions incurred prior to 2020 are subject to a 70% ‘add back’ this year in line with pre-existing transitional rules.

Why it matters

Regulatory relief measures may have aided Barclays’ capital position this quarter, but its CET1 ratio could fall precipitously if a slew of loans currently see-sawing on the brink of default suddenly fail.

Since the IFRS 9 relief does not apply to stage three loans, if a bunch of assets fall into this category over Q3, Barclays’ CET1 ratio would take a hammering. As of end-June, under 2% of gross loan exposures were classified as stage three, but almost 20% were stage two, just one step away from default.  

Barclays also warned that RWAs could drift higher over Q3, as the effect of the coronavirus crisis on outstanding credits intensifies. This would also work to push it CET1 ratio down.

Still, as of end-June the bank had 300bp of headroom above its regulatory minimum threshold, implying it could withstand consecutive quarters of capital depletion before running afoul of its supervisor.

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