UK banks pick up pace of debt write-offs as regulators reduce forbearance

In yet another sign of why market participants cannot tell which banks are solvent and which banks are not, the Telegraph ran an article on record write-offs by UK banks as regulators reduce forbearance.

Just how much bad debt banks are holding is anyone's guess.

Furthermore, banks are unlikely to recognize all their bed debt as it would make it harder to achieve the 9% Tier 1 capital ratio set by regulators.  If they write-off all their bad debt, achieving the target capital ratio could only be achieved by doing a significant stock offering.

Naturally, bank management is unwilling to do this.  Instead, to hit the capital ratio target they are minimizing both their write-offs and their lending.

This is a classic case of a meaningless number have a significant negative effect in the real economy.

In the three months to June, "write-offs of loans to non-financial corporations" almost tripled to £2.94bn, according to the Bank of England....

The sudden increase in loan losses was at odds with what was then a period of relatively benign economic conditions. 

However, it coincided with a regulatory crackdown on "forbearance" – whereby banks vary the terms of a loan to allow struggling borrowers to limp on and avoid booking losses. 

The Bank, the Financial Services Authority and the International Monetary Fund all raised concerns about the misuse of forbearance at that time, with a particular focus on commercial property. 

In June, the Bank's Financial Policy Committee said: "If provisioning is inadequate, banks' reported profits and levels of capital may provide a misleading picture of their financial health." 

The Bank has repeatedly warned about the scale of bad commercial property loans on the banks' books. 

The sharp rise in corporate write-offs in the second quarter, the most recent data available, lifted total UK loan losses – including credit cards and mortgages – to their second highest level on record. 

For the three months to June, total sterling write-offs were £5.1bn, up from £3.2bn in the first quarter. 

The largest quarterly hit came in the final three months of 2009, totalling £5.8bn. Write-downs on personal loans edged up to £2.1bn, but remained far off the peak in the same period the previous year of £3.5bn. 

The write-offs are contributing to a decline in household debt. Total household debt has dropped by £8bn to £1.45 trillion in the past year, roughly in line with the amount of personal debt lenders have cancelled. 

The rate of mortgage losses may be about to rise. Last week, Lloyds Banking Group revealed a four-fold increase in mortgage loan impairments for the nine months to September of £416m and that £38bn of loans are to borrowers who are in negative equity. 

Taking write-offs cleanses bank balance sheets but reduces the amount of capital against which they can lend. 

In reality, bank book capital is not a binding constraint on lending.  As Walter Bagehot observed, a well-run bank needs no capital.

Bank book capital is not a constraint on lending when the structured finance market is functioning.  The loans can be financed by the capital markets.

Bank book capital is only a constraint on lending if policymakers and global financial regulators make it a constraint.