By Daniel Hunter

KPMG’s UK Banks: Performance Benchmarking Report highlights how profitability at the UK’s largest banks has suffered at the hands of the Eurozone crisis and the significant costs associated with PPI, the bank levy and regulatory requirements.

The overall cost of Payment Protection Insurance (PPI) and other redress payments totalled £5.7bn and the total bank levy charge was £1.3bn.

The big five banks — Barclays, HSBC, Lloyds Banking Group, RBS and Standard Chartered — made combined pre-tax statutory profits of £19.4 billion in 2011, down £2.9 billion on profits reported in 2011.

Following a year of aggressive cost cutting and restructuring, including the offloading of non-core businesses, retail banking fared better than investment banking where revenues declined sharply compared with last year.

“It was a tougher year than many expected and banks will need to continue working hard to turn things around," Bill Michael, UK head of financial services at KPMG, commented.

"I expect we will see continued cost costing — which inevitably means further job losses — and business models will be reviewed again to ensure banks are concentrating on their core strengths and the markets with the greatest potential.

“The banks with larger exposures to Asian economies were the star performers, which reinforces how the UK and Europe are becoming relatively difficult places for banks to do business. HSBC, which has 49% of its business based in Asia and Latin America, and Standard Chartered, with 80% of its business in Asia and the Middle East, outperformed the more UK and US focused banks. As the amount of capital and liquidity required to write business in the UK becomes higher than in other jurisdictions, it is increasingly difficult for banks without an international focus to achieve the return on equity expected by investors.

“The UK bank levy knocked a significant dent in the profitability of all banks and PPI and other customer redress had an even more significant impact. In addition, the cost of regulation is starting to bite and this will not ease off anytime soon, especially as work on implementing the Independent Commission on Banking recommendations and recovery and resolution plans heats up. Add to the mix the fact that UK banks will soon be facing a new look regulatory regime presenting the significant challenge of managing a dual regulatory relationship with both the prudential and conduct supervisors.

“All in all, banking in this country requires major changes in business models and remuneration levels for staff to meet the increased capital requirements. Banks can improve their capital ratios either by raising capital or deleveraging. At present they are finding it tough to generate capital and it is therefore easier to reduce overall lending.”

Retail banking

“With interest rates at a historic low in the UK, banks continue to face intense pressure on liability margins with stiff competition for deposits to improve funding. Non-interest income has remained broadly flat compared with 2010. Against this backdrop, future profitability is a key concern for retail banks and I anticipate additional price increases for customers. Further job cuts are also inevitable.

“Mobile banking will be a battleground for 2012. The banks that are not already implementing their strategies for smart phones and tablets will lose out.

Investment banking

“The investment banking sector has had a year to forget, with the industry as a whole underperforming. While 2011 got off to a strong start, the Eurozone crisis and subdued market activity made life hard through the rest of the year. 2012 has also started well and some mild optimism has returned. Hopefully this will continue and we won’t see a repeat of last year’s performance.

“The big question for the industry is how it will consistently generate a return on equity above the average cost of capital. This is a very tough ask in the current environment and the challenge for management will be to continue driving down costs to match reduced revenue levels.”

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