De-risking efforts yet to boost profits at Lloyds

Commercial banking entity saw RWAs fall -11% in 2019

Although UK lender Lloyds lowered risk-weighted assets at its commercial banking unit in 2019, the business continues to drag on its profitability.

Lloyds lifted its group-wide Common Equity Tier 1 (CET1) capital ratio by a net 20 basis points through RWA optimisation efforts last year. RWAs at the commercial banking operation fell -11% to £77.4 billion in 2019. The unit is now 24% smaller on a RWA basis than in 2015.

Shrinking the division has not boosted profitability, however. Return on RWAs (RoRWA) stood at 2.14% in 2019, down from 2.5% in the year prior. Lloyds, as a whole, posted an RoRWA of 3.65%, down from 3.86%.

 

The retail lending business saw RWAs climb +5% to £98.4 billion year-on-year. RoRWA decreased to 3.99% from 4.57%. 

Crimping Lloyds’ profitability were charges to settle payment protection insurance claims (PPI). These lopped 121bp from the CET1 ratio, which ended the year at 13.9%, down 10bp on 2018.

Who said what

“The RWA optimisation is about improving the returns of our commercial business. If you look at the returns within our business and the capital allocation against them, it has been the case that retail has been a relatively positive return and the commercial has been positive – but it’s been less positive. We would like to correct that balance over time” – William Chalmers, chief financial officer of Lloyds.

What is it? 

RoRWA is a measure of bank profitability. Risk Quantum calculates this as pre-tax income divided by total RWAs. Lloyds calculates it as underlying profit divided by total RWAs.

RWAs are used to set minimum capital requirements for banks. Credit assets, such as loans, are assigned a risk weighting to generate their RWA value. The riskier the loan, the higher the RWA. Market RWAs are set using value-at-risk measures and other gauges of trading risk. Operational RWAs are set using banks’ own models or regulator-set formulae.

Why it matters

Lloyds’ commercial banking operations accounted for 38% of RWAs, but only 24% of underlying profits in 2019. RWAs define capital requirements, meaning the unit is tying up large amounts of capital but not pulling its weight in income. 

Lloyds executives say they are targeting “low-returning” clients in the division to try to maximise revenues. This may lead to RWAs going up in future if, for example, these customers take out funkier loans that offer Lloyds higher margins but at greater risk. 

The firm is also looking to expand its small- and medium-sized enterprise loan portfolio. These borrowers pose a greater credit risk than large corporates, but margins can also be chunkier since SMEs typically do not have dozens of global banks chasing their business.

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