Britain’s biggest banks are in a healthier shape and returning to profitability, however they must urgently tackle a low return on equity as they head towards their separate ways, according to a KPMG report.
The latest bank benchmarking report, A Paradox of Forces, which analyses the full-year results of the five biggest UK-based banks - RBS, Lloyds, HSBC, Barclays and Standard Chartered – has found their combined pre-tax profits reached £20.6bn in 2014, up £7.9bn or 62 per cent from £12.7bn the previous year.
The boost in profits was against a backdrop of total income falling by 12 per cent, or £18bn to £127.2bn, as banks focused on less riskier activities. The rate of which the banks are cutting their costs vary considerably, with the cost-income ratios varying between 51 per cent and 87 per cent.
As a result of strengthening economic conditions, total loan impairment costs fell by 72 per cent, or £13.5bn to £5.2bn. Although, the level of impaired loans as a percentage of total loans and advances to customers, fell to an average of 3.4 per cent, it is still double pre-crisis levels of 1.6 per cent. These, combined with the fact that capital ratios have been bolstered, means banks’ balance sheets are now in a much healthier state.
However the report also reveals that customer remediation, conduct failings and fines continue to be a major issue, as costs have totalled £38.7bn, over 60 per cent of their cumulative profits since 2011. Conduct costs last year was £9.9bn, just 8 per cent down from 2013, with almost half of the cost relating to the ongoing cost of Payment ProtectionInsurance and interest rate hedging.
And the UK-based banks are still not covering their cost of capital, which in the long-term, is an unsustainable position as the value to shareholders is eroding. Three out of the five banks were trading below book value and none of the banks surveyed achieved a return on equity of more than 8 per cent, compared with an average 11.6 per cent in 2009.
The report paints a picture of divergent performance across the banks as they begin to reshape their business plans. For example, profitability at the two state-backed banks continued to rise whereas it fell at the three global banks.
Bill Michael, EMA head of financial services at KPMG, added, “Banks are undergoing a once-in-a-lifetime change, as they face evolving regulation, technology and society’s expectations.
“At the same time, competition is increasing as new challenger banks and peer-to-peer platforms offer customers new ways to borrow and deposit and technology-led services such as PayPal and e-wallets change the way money is transferred and goods and services paid for.
“Domestically focused banking arms are focused on restructuring their business. Those with active investment banking arms face significant challenges around ring-fencing their retail and investment banking activities, which will become mandatory in 2019. The UK as a financial centre has largely been built on non-retail banking. If further regulation creates too many strictures on non-retail banking, the industry risks losing its global relevance.
“Some banks will follow a path of gradual evolution, others will opt for more radical strategic change. In the near-term, banks will continue to focus on cost control and invest in technology to improve services.
“While it is important to put customers first, embed cultural change and embrace technology, it will be the banks that have a clear and sustainable business model that stand the best chance of success in the future.”
Pamela McIntyre, head of banking audit at KPMG, added, “The banks are in a period of transition as they adapt their business plans to respond to the shifting regulatory landscape. The long-term outlook is still uncertain, but our report reveals there’s clear evidence of change.
“Banks have reshaped their balance sheets and are on course to meet their targets for capital, leverage and liquidity. The unanimous commitment to improve customer service also featured in the annual reports. However, ultimately one of the key measures of success is return on equity, which is still unsustainably below the banks’ cost of capital.
“Cost-cutting will continue. However banks must use new technologies to increase returns from their customer and cost reduction activities. They are challenged by accessing data integrating information across silos and complying with Basel Committee regulations. We are in an age where Chief Information Officers play an important role in defining the banks’ future directions.”
Other key findings include:
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Four of the five banks have taken the significant step of including customer satisfaction information in their annual reports
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Risk-Weighted Assets decreased by £77bn to £2tn
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Average Common Equity Tier (CET) 1 capital increased to 11.1 per cent from 9.9 per cent in 2013
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Combined loans and advances to customers declined by 2 per cent to £2.1bn
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Leverage ratios ranged from 3.7 per cent to 4.9 per cent – ring-fenced banks will have to meet ratios above 4 per cent
The full report can be downloaded here.