Morgan Stanley expects UK bank capital ratios to rise further to meet regulatory standards

US heavyweight banking titan Morgan Stanley took note of the rising capital demands for UK banks in its latest note to clients and now expects that over 13% of Common Tier Equity 1 (CTE1) ratios to become the new baseline for the sector.

“We see more evidence that the seemingly relentless march upwards of 'steady state' CET1 ratios for UK banks is set to continue,” said the US investment bank.

The term ‘steady state’ is used to define the incremental yet steady rise in capital ratios over a period.

For UK banks, it expects the 'steady state' to range from 12-14% with risk of an upward skew over time. “To be clear our 'steady-state' is not the regulatory minimum of the banks, but rather the level we expect banks to be run including any management buffer,” said Morgan Stanley.

Under its new assumptions of capital ratios, Morgan Stanley believe Lloyds Banking Group and Royal Bank of Scotland will have a considerable surplus of capital by 2017, whereas Barclays, Standard Chartered and HSBC will have moderate deficits.

“The UK banks have published targets for 'steady-state' CET1/risk weighted average ratios of HSBC 12-13%, Barclays 11.5-12.0%, RBS more than 13%, Lloyds 12%, and Standard Chartered 11-12%. This means that our 12-14% range (with upside risk over time) is higher than what most of the banks target. We believe market consensus for 'steady state' is around the levels cited by the banks, though some investors are of course more cautious,” added Morgan Stanley.

The US banking giant does however think that a more prolonged drag on returns and capital repatriation prospects from regulation will lead UK bank dividends to disappoint consensus.

That’s because Morgan Stanley expects UK policymakers to keep trying to lower the probability of bank failures, which will lead to regulators to drive capital ratios higher and tightening the calculation basis.

“However, we do believe that the capital framework the banks are being judged against is becoming clearer,” added Morgan Stanley.

It retains an ‘overweight’ rating on Lloyds and Barclays, an ‘equalweight’ rating on RBS and ‘underweight’ ratings on HSBC and Standard Chartered.