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Last week, financial markets experienced a sense of déjà vu as bond yields rose and the share price of a midsized bank plummeted once again. However, Metro Bank’s urgent need to strengthen its balance sheet should not be mistaken for a repetition of the US banking crisis that occurred earlier this year, resulting in the collapse of three American regional lenders, including Silicon Valley Bank. Despite Metro Bank’s rising stock on Monday, it is important to note that the bank is not considered systemically important in the UK. Additionally, the bank secured a £925 million refinancing deal with investors, leading to a Colombian billionaire taking control of a majority stake.
Metro Bank was launched in 2010 as the UK’s first new high street bank in over a century. Investors were initially optimistic about the competitive opportunity it presented, especially considering the established lenders’ struggle in the aftermath of the financial crisis. However, Metro Bank faced challenges in penetrating the market share of major lenders, as digital groups like Monzo and Starling emerged. The recent troubles of Metro Bank further highlight the complex task faced by regulators in fostering competition among large incumbents while ensuring financial stability.
The high rate environment resulting from rising interest rates has exposed vulnerabilities in smaller banks, causing concern among investors. Just like Silicon Valley Bank, which had an asset portfolio exposed to rising bond yields, Metro Bank had its own vulnerabilities, including high funding costs. These weaknesses compounded other issues such as a high-cost, branch-centered business model and an accounting scandal in 2019. Last month, Metro Bank announced a regulatory approval delay for capital relief, triggering a significant decline in its share price.
Rapid action by the Prudential Regulation Authority, the UK banking supervisor, prompted Metro Bank to strengthen its finances. The eventual deal resulted in shareholders and bondholders taking losses, effectively preventing contagion. Mergers and acquisitions offer potential solutions for small banks seeking to raise capital and achieve cost efficiencies. However, Metro Bank received limited interest from potential suitors due to the significant upfront expenses associated with acquired assets being marked down at high rates. Regulators must assess whether other policies are discouraging viable acquisitions.
Although challenger banks are relatively small in scale and have simpler operations, they still require close monitoring. American regional lenders faced less stringent stress tests and liquidity requirements due to arbitrary regulatory thresholds on total assets. The bank runs experienced by Silicon Valley Bank and Signature Bank in March left little time for resolution. In Europe, broader oversight acknowledges the contagion risks posed even by small banks, particularly in the era of digital bank runs.
However, it is important to strike a balance and avoid burdening challenger banks with excessive regulations. While the requirement for banks to issue loss-absorbing debt provided some cushion for Metro Bank, the impact on smaller banks with limited access to capital markets should be considered. Alternative buffers may be more appropriate. Metro Bank and other small European banks have struggled to raise costly debt in the past.
At the same time, challenger banks should demonstrate their maturity before being granted flexibilities. Metro Bank’s track record and limited data likely influenced the Prudential Regulation Authority’s decision not to allow the use of its own risk models, opting for a more conservative standard to assign risk weight to its assets.
Metro Bank, the most prominent challenger bank in Britain, survives to fight another day. Its recent tribulations serve as a reminder that while a balanced approach is necessary to nurture a competitive banking market, regulatory oversight and expectations for governance standards should not be overlooked when it comes to small banks.
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