Major British banks (i.e. the high-street groups covered by British Bankers' Association statistics) incurred impairment charges of £31 billion in the first half of 2009, up from £26 billion in the second half of 2008, according to recent interim statements. As explained below, a comparison with the bad debt cycles of the early 1980s and early 1990s suggests further provisions of £100-150 billion over the three and a half years to the end of 2012.
More optimistically, the same group of banks made pre-impairment operating profits of £26 billion during the first half. Providing this run-rate is maintained, cumulative profits between the second half of 2009 and 2012 should be sufficient both to cover future impairments and allow some addition to capital, implying no need for a further government "bail-out".
Loss provisions by major banks totalled 9% of credit exposure over the five years from 1982 to 1986, following the 1979-81 recession, and 7% over 1989-93, encompassing the 1990-91 recession. The 1982-86 figure includes losses on sovereign loans, although these were not formally recognised until later in the 1980s. (See previous post for more details.)
A similar loss rate, i.e. between 7% and 9% over five years, is plausible in the current cycle. It is not clear that recent bank behaviour was any more reckless than in the rush to lend to developing countries in the late 1970s or the property lending boom of the late 1980s. Moreover, nominal and real interest rates are much lower than in the 1980s and 1990s, which should limit defaults.
Based on 2008 exposure, a 7-9% rate of attrition would imply credit losses of £190-240 billion over the five years 2008-12. Impairment charges totalled £64 billion in 2008 and the first half of 2009 so this suggests losses of £125-175 billion over the three and a half years to the end of 2012.
In addition to impairment charges, however, Lloyds, HBOS and RBS recorded a combined net trading loss of £23 billion in the 18 months to mid 2009, reflecting writedowns of securities. On the basis that banks held a much greater proportion of credit exposure in securitised form in the current cycle, such writedowns should be included in total losses recognised to date when comparing with the early 1980s and early 1990s.
A conservative approach is to incorporate only the net trading loss of these three banks, rather than aggregate trading writedowns. (Writedowns by other banks have been offset by income from other trading activities.) Assuming no further trading losses, this reduces the forecast range for provisions to £100-150 billion between the second half of 2009 and 2012.
The chart translates this range into a half-yearly profile, assuming that impairments decline steadily from a peak in the first half of 2009. The middle of the range implies annual totals of £57 billion, £40 billion, £23 billion and £6 billion over 2009-12.
Banks' pre-impairment profits of £26 billion during the first half of 2009 incorporate £6 billion of trading gains by Barclays and RBS, offset by a further £3 billion loss by Lloyds / HBOS. Investment bank profits could be less favourable going forward but any decline should be offset by higher net interest income as average lending / deposit rate spreads recover from recent lows – see previous post on banks' margins.
If pre-impairment profits are stable at £26 billion per half-year – arguably cautious – and impairment charges total £100-150 billion between the second half of 2009 and 2012, banks will earn cumulative post-provision profits of £30-80 billion by the end of 2012. This surplus will be available to boost capital levels, on top of any addition from further fund-raising in markets.