Barclays(LSE: BARC) sailed through the ECBs stress tests, the results of which were released this weekend. Indeed, the ECB revealed that Barclayspassed its rigorous set of tests with a core capital ratio of 7.1%, 1.6% above the required minimum.
However, the bank is not out of the woods just yet as, alongside the ECBs tests, the Bank of England is also conducting its own set of stress tests, which are designed to be much tougher than those conducted by the ECB.
The BoEs tests are designed to be more rigorous than those of the ECB. For example, the BoE is testing lenders using a broader range of criteria,focusing on banks leverage ratios how much equity capital they hold against their assets.Whats more, due to the way the BoEs tests will be conducted, the bank will be unable toweight assets according to risk, in order to reduce capital needs.
This is where Barclays is likely to fall down. You see, Barclays has one of the biggest investment banking arms of any UK based lender. As a result, the investment banking arm has a high leverage ratio.
Barclays has been trying to improve its leverage ratio over the past year, targeting the 3% minimum imposed by regulators. At the end of the second quarter Barclays leverage ratio stood at 3.4%, while its Tier 1 ratio increased to 9.9%, from 9.6% as reported at the end of the first quarter.
However, the BoE did warn duringJuly that systemically important banks must boost their leverage ratios above the 3% minimum level. Due to its size, Barclays is consideredasystemically important bank.
So, based on these assumptions and Barclays current level of leverage, some City analysts believe that the bank could be facing a capital shortfall of 24.1bn.
Bolstering the balance sheet
Barclays will have its work cut out if the group is really facing a 24.1bn capital shortfall. Many analysts believe that the bank will be forced to sell-off, or wind down several non-core divisions and assets in order to raise cash and reduce its leverage. Moreover, the possibility of yet another rights issue remains.
Then theres the question of the banks dividend payout. Indeed, while management has stated its commitment to the payout, it makes no sense to maintain the payout while the bank is struggling to meet capital requirements.
Even if Barclays does choose to maintain its dividend payout, theres still a chance that regulators could clamp down on management. Barclays could be forced to prioritise its capital position before distributing profits to investors.
Only time will tell
Still, only time will tell if Barclays leverage ratio will meet the required targets and what course of action regulatorswill take if the bank fails to meet leverage targets. However, one thing is for sure Barclays future is uncertain.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.