FSA to banks: Cut returns and dividends

THE FSA has warned banks that they might have to cut their targets for returns on equity (RoE) in order to meet a capital surcharge for major financial institutions.

It has also said that it will remain “vigilant” to banks taking “excessive risks in an attempt to maintain return on equity”.

In its annual Prudential Risk Outlook, the FSA warned that banks will only be able to achieve the necessary capital ratios “provided dividend payout rates are not excessive” and by restraining pay.

FSA chairman Lord Turner (pictured) also reiterated that he favours counting capital in the form of equity rather than debt, saying: “There is a significant global support for an element of equity. The argument that equity is the best form of [capital surcharge] has significant support around the world.”

Turner’s view makes it likely that if UK banks are allowed to use forms of debt to fulfil their core tier one capital requirements, they will have to be convertible into equity if their capital ratios fall too low and might have to use a highly cautious “exchange rate” for the conversion.

Banks are keeping a keen eye on the different forms of capital-raising available, with Credit Suisse having already gone ahead with two rounds of contingent convertible (co-co) bond issuances in order to fulfill Swiss regulatory requirements.

Simon Morris of law firm CMS Cameron McKenna said: “The FSA has gained a name for its poor grasp of macro-prudential regulation. There is the consequent risk that the FSA report is unduly negative because it is compensating for having missed the macro-prudential warning signs of the last crisis.”

At the launch of the prudential outlook report, David Rule of the FSA’s macro-prudential team also estimated that UK banks’ exposure to Japan runs as high as £136bn.