The lessons from Metro Bank’s struggles

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Last week, as bond yields soared and another midsized bank’s share price tumbled, financial markets felt a touch of déjà vu. But Metro Bank’s urgent need to shore up its balance sheet was not a rerun of the US banking crisis earlier this year, when three American regional lenders including Silicon Valley Bank collapsed. For starters, Metro Bank is not systemically important in the UK. On Sunday, it also struck a £925mn refinancing deal with investors, which saw a Colombian billionaire seize a controlling stake. Its stock started rising again on Monday.

When it was launched in 2010, it was the UK’s first new high street bank in over a century. Investors were excited by the competitive opportunity as established lenders had been laid low by the financial crisis; digital groups such as Monzo and Starling also emerged. But few have eaten into the market share of the major lenders. Metro Bank’s recent problems only underscore the multiple challenges authorities face in nurturing competition for large incumbents that benefit from network effects, while also maintaining financial stability. 

First, though retail banks tend to benefit as interest rates rise, the high rate environment has exposed weaknesses in small and midsized banks to jittery investors. Like SVB, which had an asset portfolio exposed to rising bond yields, Metro Bank had its own vulnerabilities, including high funding costs. This built on existing flaws, including a high-cost, branch-centred business model and an accounting scandal in 2019. Then last month it announced a delay in obtaining a regulatory approval for a capital relief, which triggered a plunge in its share price. 

Second, while exposing weak links in the banking sector is a good thing, regulators need to act quickly to contain any fallout. The Prudential Regulation Authority, the UK banking supervisor, was quick to press Metro Bank to bolster its finances. The final deal meant shareholders and bondholders took hits, and contagion was avoided. Scaling through mergers and acquisition is another option for small banks looking to raise capital, and deliver cost efficiencies. But few came forward for Metro Bank. The upfront expense needed to cover acquired assets, which are required to be marked-down by high rates, were a likely deterrent. Regulators need to assess whether viable acquisitions are being discouraged by other rules.

Third, challenger banks still warrant close monitoring, despite their scale and simplicity. Arbitrary regulatory thresholds on total assets left American regional lenders below stipulations faced by the biggest US banks for more stringent stress tests and liquidity requirements. The speed of the bank runs in March at SVB and Signature Bank then left little time for a resolution. Europe tends to apply broader oversight, which acknowledges the contagion risks that even small banks can pose. This is salient in an age of digital bank runs.

But proportionality is needed. Challenger banks should not be overburdened by regulations. The requirement for banks to issue loss-absorbing debt provided a cushion for Metro Bank. But there is a broader need to assess whether so-called MREL debt can stunt smaller banks, with less access to capital markets, and if alternative buffers are more appropriate. Metro Bank, like other small European banks, has struggled to raise this costly debt in the past.

It is also fair, though, to require challenger banks to prove their maturity before granting flexibilities. Indeed, Metro Bank’s record and limited data probably featured in the PRA’s reluctance to permit it to use its own models, rather than a more conservative standard, to risk weight its assets.

Britain’s best-known challenger bank lives to fight another day. Its recent troubles are a reminder that even though authorities may need to take a balanced approach to help nurture a competitive banking market, regulatory monitoring and expectations of governance standards in small banks should not slide.