Metro Bank stock price plunged 20% as British regulators investigate the bank's misclassified assets
. Given that the bank uses Basel III’s standardized approach, which is a proscriptive approach where the regulator sets the risk-weights banks have to use, it is unclear thus far how the bank gave lower risk-weights to its mortgage portfolio.
Assigning the wrong risk weight to any portfolio, accidentally or on purpose, has serious consequences for a bank, because investors rely on banks’ capital ratios to determine the credit risk that any bank poses to those market participants who have bought that banks’ bonds or to financial institutions to lend to a bank. Banks have Basel III guidance and national regulatory guidelines for how they need to classify the probability of default and loss severity of any type of loan.
Chief Executive Officer Craig Donaldson has announced that Metro Bank, with the help of RBC Capital Markets, Jefferies and KBW, is presently getting ready to sell £350 million worth of shares in order to increase its capital levels. If the sale goes through and there is demand for the shares, this will help the bank increase its common equity Tier I levels in order to comply with bank capital regulatory requirements.
Even if Metro Bank can raise capital, these actions may be too little to late. If bank counterparties get nervous, they will not make loans to Metro Bank and can close-out existing credit lines. As we saw during the Lehman crisis, banks can be adequately capitalized but become illiquid when market participants get spooked. Unfortunately, illiquidity can quickly become insolvency. The coming days for Metro Bank senior executives and risk managers are critical.
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