The Too Big To Fail Subsidy in UK Banking: a concrete example

From the CMA inquiry into retail and SME banking, here is a case study from a new entrant, Metro Bank:

Capital requirements

37.

Metro stated that it was currently required to hold around six to ten times more

capital than the big banks and building societies when securing a mortgage

for a customer, even if it was for the same customer, with the same deposit,

on the same property – a situation which did not reflect a level playing field.

 

38.

To elaborate this point, Metro told us that as a new entrant to the market, it

had to use the standardised approach (SA) to credit risk when calculating

capital requirements, while the larger banks were permitted to use an internal

ratings based approach (IRB). Metro indicated that the IRB approach was

based on many years of data, and enabled certain institutions to significantly

reduce the value of their risk-weighted assets.

Note that  the IRB is a calculation done by the banks themselves.  

40.

Metro pointed out to the CMA the difference between the SA and IRB by

using an example of

a low loan- to -value residential mortgage.Metro stated

that such a mortgage carried the same risk profile regardless of the lending

institution but the challenger banks risk weight these particular assets at 35%

compared with 3 to 6% for the larger banks.

And here's the answer from the regulators

42.

In March 2013, the FSA and the BoE announced a shift in approach to the

prudential regulation of banking start-ups whereby the additional requirements

(known as ‘add-ons and scalars’) previously applied to reflect the

uncertainties inherent in start-ups were no longer to be applied. These

requirements according to the two regulators often resulted in capital and

liquidity requirements for start-ups being higher than for existing banks.

43.

In a follow-up review, the PRA and FCA referred to the IRB approach to

calculating credit risk versus the SA (the default position) for all new and

existing banks and noted that ‘The PRA has taken steps to address

underestimation of risks that can result from applying the IRB approach to

certain types of exposures.’ According to this review, the PRA was to

continue to consider the impact of its policies on competition as required by its

competitive objective with a caveat that the regulatory capital requirements

were to a large extent determined by the relevant EU legislation over which

PRA had little or no discretion