20 Jun 2013

Extra capital for UK banks. How not paying tax helps

You could call it Mervyn King’s leaving present. It is the day that Britain’s banks were forced to “pad up”.

We already knew that the financial policy committee of the Bank of England wanted Britain’s banks to hit effective capital ratios of 7 per cent. The brouhaha over Co-op has been about how they would do that.

This morning, at 7am, the Prudential Regulatory Authority released results as to what this would mean in practice: £27.1bn in extra capital for Britain’s banks.

Just over half of that, £13.6bn,  is for RBS alone, for Lloyds (basically the HBoS toxic legacy) it is £8.5bn, £3bn for Barclays, £1.5bn for the Coop, and £400m for Nationwide.

HSBC, Standard Chartered, and Santander UK are already there.

These numbers already contain existing announced plans to raise capital, Lloyds stands out as the bank required to raise the most at £7bn over and above existing plans versus £3.2bn for RBS.

Barclays says the funds will be raised “organically” with no need for a capital raising. Lloyds I will update you on. Co-op has bailed in some bondholders and will end up on the stock market.

RBS is rather intriguing. Of the £3.2bn, it says already planned action will reduce this to £0.4bn by the end of the year.

I will just focus on one note in its response:

“Note that deferred tax asset deduction is taken in full: with an impact of 70bps on CT1 (core tier 1). The real capital benefit of this asset for RBS will emerge for the next five years as the group returns to profitability”.

In English, this means that the horrific losses made by RBS over the past few years will be used as an asset on the balance sheet, a form of capital.

It is an asset because, under conventional accounting law, you can book these losses against future profits for the purposes of corporation tax.

To clarify further that means RBS will not pay corporation tax for years and years, at least five years according to this note. By my calculation, it has saved RBS around £4bn in capital (70 basis points of its 6.5% ratio, of £37.2bn).

Two issues arise:

•   How is a promise not to have to pay tax a tenth of RBS’ capital base?

•   How does everyone feel about RBS, whose losses were bailed out and underpinned by the taxpayer, then using those same losses not to pay tax for many years to come after it is nursed back to profitability?

Perhaps Labour might have a few answers. Surrendering the deferred tax asset was part of the original asset protection scheme bailout in 2009.

Over the course of the negotiation that clause disappeared for a reason I have not quite managed to put my finger on.

Credit to Stephen Hester for winning this concession, he was doing his job (and I had a minor debate with him about this calling it a “double bailout” in an interview last year).

But faced with other concerns about tax, justice, banking, and a fundamental review of RBS’s role, purpose and split, surely this should be in the mix.

11 reader comments

  1. Philip Edwards says:

    Faisal,

    I like that “organically.”

    Were the transnational swindles “organic” too? If so, who played the organ?
    :-)

  2. purpleline says:

    This perfectly right for them to do and is a major accounting principle that underpins our economy and capitalist system.

    To highlight RBS and not every other corporation is a little below the belt for Channel4 who I assume take playing within the Tax rules for their own business as every normal business. In fact we should highlight C4 taxpayer funded status and ask could we be doing something better with the money?

    1. JohnD says:

      Channel4 is a commercially funded media organisation and receives no public funding whatsoever.

  3. Ben says:

    It seems strange, when ‘bail-in’ instruments are in vogue for strengthening a bank’s capital base when it gets in trouble, that a bank can use DTAs to boost its capital ratio. Surely these are the worst kind of capital, as they evaporate as soon as a bank gets in financial difficulties. At that point, its future profits disappear and it has to write down its DTAs. That seems crazy to me.

  4. Nicholas Shaxson says:

    You make good points – but as I understand it, it’s even worse than that. Deferred tax assets from carrying losses forwards are a silly form of bank capital. Look at this from FT Alphaville, a while ago.
    http://ftalphaville.ft.com/2009/12/18/116341/basel-blows-out-dtas/

    “[DTAs] only apply if banks are making enough money. In times of losses they’re almost completely useless and are simply carried forward until a time when (hopefully) the bank is generating enough to use them.”

    In other words, when times are good, the bank can use them to appear well capitalised. But when things go pear-shaped – which is precisely when capital suddenly becomes mega-important – the bank won’t be making any profits to set those DTAs against. What are the odds a bank will be making money when it needs capital the most?

  5. Peter Gresswell says:

    Isn’t this us paying tax to us? As long as it is is not carried over into the privately owned RBS after privatisation what difference will it make?

    1. Andrew Dundas says:

      Tax losses are the property of RBS, Lloyds et al. Part of their assets. Part of the market valuation of their shares.

  6. J bowers says:

    Of course a business should be able to offset losses from one year against profits from another.

    What about those industries which don’t complete a whole cashflow cycle within a tax year?

    For instance, oil exploration racks up vast losses for years, and then suddenly the oil comes onstream and the money flows. You think the profits in the production phase should be taxed without looking at the costs of exploring and developing the wells?

  7. rajkumar thomas says:

    Faisal,

    Iwould much appreciate it when you interview someone re the Spending review from the coallition, hopefully the Chancellor, you ask him to cease and desist from claiming that they have reduced the deficit by a third.

    It is a Big lie.

    When they entered government the deficit was £159 Billion on the latest revision it is £118.8 B, therefore roughly a £40 Billion reduction which by approximation is a nudge over 25%.

    To have reduced it by 33% would mean it was at £106B

    As the country’s chief bean counter I think he should apologise to the public as the coallition has repeatedly crowed on tv and radio that they have reduced it by a third, how can they be belived if they can not do simple arithmetic?

    I hope you view this gross misstatement worthy of correction, albeit a mere £12.8 Billion error.

    PS I can only assume they are using the current annual deficit as the denominator instead of the starting annual figure.

    If they continue, then if and when the annual deficit is further reduced to £80 B they will be claiming that they have reduced the deficit by 100% whist a mere £80 Billion annual deficit will bemuse me and the British public.

    Hope…

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