You can bank on it

From Lehman's to NatWest: why the banking rules may be up for reform.

The collapse of Lehman Brothers was the largest bankruptcy in US history. The New York-based investment bank had assets worth $691 billion when it filed for bankruptcy on the 15th September 2008. This was primarily due to the bursting of a US housing market bubble and the firm’s exposure to the subprime mortgage market.

This collapse created the global financial crisis, which saw the UK banking sector implode with the crash of Northern Rock and Bradford & Bingley. The crisis also prompted a government bail-out of major UK banks, most notably the Royal Bank of Scotland and Lloyds TSB. Following the crisis, new regulatory measures were introduced including greater banking capital requirements and, in the UK, ‘ring-fencing’ which created a firewall between investment banking and retail operations.

Fast-forward to last week, and the UK government finally sold the last of its stake in NatWest. This compares with the peak public ownership stake of 80% shareholding, post a £45bn bail-out.

Now, the UK’s leading banks have asked Chancellor Rachel Reeves that the ring-fencing regime be removed. The banks believe ring-fencing imposes significant costs on business customers by exposing them to banking constraints, not experienced by their international competitors, making it harder for them to compete. The Chancellor has said ‘if we want the UK to grow, we need a thriving banking sector and creating the right environment for that is a top priority for me. I am open-minded about the case for further reform.’

This comes as US authorities are preparing to announce one of the biggest cuts in bank capital requirements for more than a decade, as part of Trump’s deregulation agenda. Regulators will reduce the Supplementary Leverage Ratio (SLR). This requires big banks to have a pre-set amount of high-quality reserves or capital such as US Treasuries, to act as leverage against liabilities such as loans and derivatives. US Treasury Secretary Scott Bessent said such a reform was a ‘high priority.’ Federal Reserve Chair Jerome Powell said, ‘we need to work on the Treasury market structure, and part of that can be, and I think will be, reducing the calibration of the SLR’.

While lowering bank sector capital requirements should boost economic growth, it does not come without risk. Given the state of the world, there are all sorts of risks out there – tariffs, war, cyber-attacks, crypto-currencies. Many of these are ‘known-knowns’ and the trouble with banking is that it is the ‘black swan’ events – those that boards are not aware of that tend to lead to a crisis. The Chancellor has a difficult decision in that she needs to strengthen the UK’s position as a leading international financial centre while ensuring the UK’s banks are secure from any future global shocks.

Given UK taxpayers lost £10bn over the course of the NatWest bail-out, some of the Chancellor’s party colleagues are demanding a wind-fall tax on the banking sector, to fund public services!

What have we been watching?

A shorter trading week with the Bank Holiday in the UK and Memorial Day in the US, but what a week with yet more unexpected tariff twists! In the space of a week, Trump imposed a 50% tariff on the EU, the same tariff was then delayed by 5 weeks, the US Court of International Trade ruled most of Trump’s tariffs were illegal, the Court of Appeal then granted a temporary stay that leaves the tariffs in place and finally Trump doubled down on sector tariffs by doubling the tariffs on steel and aluminium to 50%. It really is hard for global investors to keep up!

 

The US Court of International Trade ruled that Trump did not have the authority to impose most of the tariffs that have been announced. It said that the Trump administration exceeded their legal authority and that the International Emergency Economic Powers Act ‘does not authorise the President to impose unbounded tariffs.’ This ruling covers the 10% baseline tariffs, the 25% tariffs on Canada and Mexico, the additional 20% tariffs on China as well as all the reciprocal tariffs that have been paused until the 9th July. However, it excludes tariffs on steel, aluminium, and autos.

In response, the Justice Department filed an appeal with the US Court of Appeal which has allowed the tariffs to temporarily stay in place, giving a 9th June deadline for briefs on the administration’s request for a longer-term stay on the trade court’s tariff suspension. The case is likely to go to the Supreme Court.

In the meantime, this has all added to market uncertainty, as alternative tariff strategies are considered. For example, one extreme might be to use his ‘Big Beautiful Bill’ that is working its way through the Senate to change the tax treatment of foreign capital which could see the US pivot from a trade to a capital war! Another option for Trump would be the use of tariff instruments on national security grounds like those used for steel and autos. However, the ruling is clearly a major setback for Trump’s tariff strategy and will complicate current attempts to negotiate concessions from trading partners, given the possibility that the tariffs might not come into effect once the current 90-day extension period is over. The ruling could also have broader implications for the US, as Trump had been hoping to use tariff revenue to fund other tax cuts.             

 

To add to the uncertainty, on Friday Trump then accused China of ‘totally violating its agreement with us’ and doubled all tariffs on steel and aluminium to 50%. Over the weekend, President Xi Jinping said the US had ‘severely violated’ the trade truce with China.   

US and Chinese relations further soured over the weekend following a defence forum in Singapore at which US Defence Secretary Pete Hegseth suggested America’s allies in Asia should boost defence spending to 5% of GDP and that the region should prepare for a potential China invasion of Taiwan.   

 

Meanwhile, Trump is growing increasingly frustrated with Putin as Russia intensifies attacks on Ukraine. ‘We’re going to find out whether or not he’s tapping us along. If he is, we’ll respond a little bit differently but it will take about a week and a half, two weeks.’ However, Trump has not delivered on previous such threats. Despite further talks in Istanbul between Russia and Ukraine, Putin looks to be preparing to launch a summer offensive with 50,000 Russian troops reported along the northern Sumy region.

 

The surprise tariff ruling came as global bond markets had come under pressure earlier in the week. The main catalyst for that was a weak 40-year bond auction in Japan. However, this followed a fall in the 30-year Japanese bond yield which saw the biggest drop since the regional banking turmoil of March 2023. There was speculation that Japan’s finance ministry was about to cut long-dated bond issuance, leading to a huge rally amongst these bonds.

 

Global bond yields remain elevated as fixed interest investors remain concerned about the US debt trajectory. As a reminder, Trump’s ‘Big Beautiful Bill’ which narrowly passed in the House of Representatives by just one vote and is forecast to add an eye-watering $4trillion debt, taking US borrowing as a percentage of GDP from 98% to 125% over the next ten years. The US 30-year yield had reached as high as 5.15% before edging back to within a whisker of 5%.

 

Elevated bond yields are likely to place further pressure on Chancellor Rachel Reeves. There was some good news in that the IMF upgraded its UK 2025 economic growth target from 1.1% to 1.2% but did warn that the government needs to stick to its fiscal rules of balancing spending against receipts by the end of the Parliament. The UK government is due to announce its Spending Review on 11th June. However, any leeway the Chancellor had has disappeared already and public sector pay rises are ahead of inflation while the government now appears to be making a U-turn on previous savings such as the Winter Fuel Allowance and second child limit on Child Benefit. One leading UK economist has already suggested the Chancellor could lose £24bn of headroom, creating a shortfall of £14bn around the fiscal rules.  More tax increases loom and the Chancellor may be forced to follow the IMF’s suggestion and loosen the fiscal rules. Meanwhile, the cost-of-living crisis also shows no sign of easing as food inflation rose to 4.1% in April probably reflecting both producers and the supermarkets raising prices to cover cost increases of National Insurance.

Read our latest investment insights from Alpha PM

 

Brent oil rose very slightly to over $64 despite news that OPEC + is to increase supply for a third month in a row in July by 411,000 barrels a day.

Finally, in a recent Alpha Bites ‘Dragged through the dirt’ we highlighted the risk to Europe’s undersea power and communication cables. Poland recently reported that a Russian ship, that is under sanctions and part of Putin’s shadow fleet, was performing ‘suspicious manoeuvres’ near the cable connecting Poland and Sweden. Meanwhile, the UK’s National Cyber Security Centre has warned of a ‘malicious cyber campaign’ targeting multiple organisations involved in delivering foreign assistance to Ukraine. More dirty tactics from Putin!

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