Barclays PLC – Annual report – 31 December 2018
A constantly evolving operating environment
Barclays is a transatlantic consumer and wholesale bank, anchored in our two home markets of the UK and US, therefore impacted by a wide range of macroeconomic, political, regulatory and accounting, technological and social developments. The evolving operating environment presents opportunities and risks which we continue to monitor and evaluate to ensure that we appropriately adapt our strategy and its delivery.
The global economy continued to expand in 2018, at an estimated rate of 3.7%a. However, there have been noticeable regional differences. US expansion accelerated through higher consumer spending as tax cuts boosted disposable income. On the other hand, growth in Japan, Eurozone and the UK slowed amid political and economic disruption. Significant concerns remain around the sustainability of the sovereign debt level in Italy. Emerging markets diverged due to higher interest rates in the US, volatile oil price and escalating trade tensions.
Central banks continued tightening monetary conditions, notably, the Federal Reserve and Bank of England increased their policy rate and the European Central Bank (ECB) announced the end of its quantitative easing programme. Labour markets have tightened, putting upward pressure on inflation, indicating potential further monetary tightening.
Barclays’ business mix spans multiple geographies and client types – we believe a diversified portfolio lowers volatility and enhances stability in a macro environment such as ours today. As a result, we believe in Barclays’ ability to generate solid returns through economic cycles, even when some areas perform less well than others.
Global political uncertainty continued to manifest itself in 2018. Conflicts remained unresolved in some areas of the world, such as Asia, the Middle East and Eastern Europe. In addition, rising trade tensions across the globe are starting to have a negative impact on economic activity, consumer confidence and general financial conditions. The possibility of an escalating trade conflict between the US and China would likely have significant and wide-ranging economic and political consequences. Separately, Brexit continues to give rise to significant uncertainty across the socio-economic environment in Europe.
The uncertain political environment may impact market dynamics and sentiment – however, we believe in Barclays’ ability to adapt to changes for the benefit of customers, clients and broader stakeholders.
From 1 January 2019, the largest UK banks were required to have separated core retail banking operations from investment banking and international banking activities to comply with the Financial Services (Banking Reform) Act 2013. These banks have had to restructure their activities and operations on a scale rarely seen before to comply with the new legislation. These changes have had implications for almost all stakeholders, with banks particularly focused on minimising disruption for clients and customers.
On 1 April 2018, Barclays’ UK banking business, largely comprising of Personal Banking, Barclaycard Consumer UK and Business Banking, was transferred from Barclays Bank PLC (BBPLC) to Barclays Bank UK PLC under the single ring-fencing transfer scheme. The corresponding products and services including current and savings accounts, consumer lending, credit cards, investment products and services, and business banking solutions, were also transferred.
Separately, as a consequence of the likely departure of the UK from the European Union (EU), financial services firms that previously accessed European markets through the UK, will need to establish new legal entities in Europe to ensure business continuity and minimise disruption to clients. Banks in particular are having to implement significant changes that include but are not limited to; the transfer, or recruitment, of colleagues into the EU; building infrastructure; transfer of balance sheet; and trades.
To help manage the risks related to Brexit, Barclays is expanding its existing banking subsidiary in the EU, Barclays Bank Ireland PLC (BBI). BBI will become a wholly owned subsidiary of BBPLC, through which we will be able to continue to serve our European clients globally and our global clients in Europe. We currently already have branches of BBPLC in key European jurisdictions, which will become branches of BBI as part of our response to the UK exiting the EU. We continue to work closely with our regulators in the UK and Europe to ensure we will be able to support our clients in Europe, and globally, from the moment the UK leaves the EU. However, execution risks remain for the industry as a whole, including but not limited to balance sheet and trade transfers, client readiness and operational resiliency.
The revised Payments Services Directive (PSD2) and Open Banking went live in early 2018. These initiatives require banks to share more customer information, subject to customer consent, with regulated third parties than ever before. Such regulatory changes are designed to bolster innovation and market competition. This poses challenges to the traditional banking business model, however, opportunities exist for banks that develop new products and services to customers, improve customer journeys, and extend beyond traditional financial products.
The EU General Data Protection Regulation (GDPR) came into effect in May 2018. The GDPR aims primarily to give individuals control over their personal data and to simplify the regulatory environment for international business by unifying the regulation within the EU. In today’s modern economy, data is becoming increasingly important and banks are emerging as key custodians of customers’ and clients’ data.
Barclays has a history of innovation spanning three industrial revolutions. We want to lead the change, being technological, regulatory, or customer driven, rather than simply responding to it. We are committed to providing a market leading digital offering to our customers and clients by making customer journeys simpler and more intuitive and offering and building digital platforms that benefit the whole society and economy.
Risk review (extract)
Material existing and emerging risks (extract)
Material existing and emerging risks potentially impacting more than one principal risk (extracts)
i) Business conditions, general economy and geopolitical issues
The Barclays Group business mix spreads across multiple geographies and client types. The breadth of these operations means that deterioration in the economic environment, or an increase in political instability in countries where Barclays Group is active, or in any systemically important economy, could adversely affect Barclays Group’s operating performance, financial condition and prospects.
Although economic activity continued to strengthen globally in 2018, a change in global economic conditions and the reversal of the improving trend may result in lower client activity in Barclays Group, including lower demand for borrowing from creditworthy customers, and/or a reduction in the value of related collateral and/or an increase of Barclays Group’s default rates, delinquencies, write-offs, and impairment charges, which in turn could adversely affect Barclays Group’s performance and prospects. Deteriorating economic conditions could also impact the ability of Barclays Group to raise funding from external investors. In addition, a shift in the forward looking consensus view of economic conditions may materially impact the models used to calculate expected credit losses (ECL), where an increase in ECLs could adversely affect Barclays Group’s profitability.
In several countries, reversals of capital inflows, as well as fiscal austerity, have already caused deterioration in political stability. This could be exacerbated by a renewed rise in asset price volatility or sustained pressure on government finances. In addition, geopolitical tensions in some areas of the world are at risk of further deterioration, thus potentially increasing market uncertainties and adverse global economic and market conditions, which in turn could adversely affect Barclays Group’s profitability in certain geographical locations.
In the UK, the vote in favour of leaving the European Union (EU), see ii) Process of UK withdrawal from the European Union below, has given rise to political uncertainty with potential consequences for investment and market confidence. The initial impact was a depreciation of Sterling resulting in higher costs for companies exposed to imports and a more favourable environment for exporters. Rising domestic costs resulting from higher import prices may impact household incomes and the affordability of consumer loans and mortgages, resulting in reduced business and, thereby, negatively impacting Barclays Group’s profitability. In turn this may affect businesses dependent on consumers for revenue, exacerbated by current pressures on businesses dependent on discretionary purchases. There has also been a reduction in activity in both commercial and residential real estate markets which has the potential to impact the value of real estate assets and adversely affect mortgage assets. Furthermore, continued uncertainty in the withdrawal process could have a detrimental effect in the economic environment in continental Europe, which may negatively impact Barclays Group’s business in specific Eurozone countries.
In the US, where the economy outperformed other key markets in 2018, there is the possibility of significant continued changes in policy in sectors including trade, healthcare and commodities which may have an impact on associated Barclays Group portfolios. A significant proportion of Barclays Group’s portfolio is located in the US, including a major credit card portfolio and a range of corporate and investment banking exposures. Stress in the US economy, weakening GDP and the associated exchange rate fluctuations, heightened trade tensions, an unexpected rise in unemployment and/or an increase in interest rates could lead to increased levels of impairment, resulting in a negative impact on Barclays Group’s profitability.
As anticipated, most major central banks have started tightening their monetary policies in 2018 and there remains a possibility that this will continue. The risk of large capital flows spawned by divergent or differently timed policies remains, and this will continue to provide financial market turbulence, in particular in emerging market economies. This may negatively impact Barclays Group’s business in the affected regions, under both profiles of credit and market risk.
Sentiment towards emerging markets as a whole continues to be driven in large part by developments in China, where there is some concern around the ability of authorities to manage growth while transitioning from manufacturing towards services. Although the Chinese government’s efforts to stably increase the weight of domestic demand have had some success, the pace of credit growth remains a concern, given the high level of leverage and despite regulatory action. A stronger than expected slowdown could result if authorities fail to appropriately manage the end of the investment and credit-led boom.
Deterioration in emerging markets could affect Barclays Group if it results in higher impairment charges for Barclays Group via sovereign or counterparty defaults. More broadly, a deterioration of conditions in the key markets where Barclays Group operates could affect performance in a number of ways including, for example: (i) deteriorating business, consumer or investor confidence indirectly having a material adverse impact on GDP growth in significant markets and therefore on Barclays Group’s performance; (ii) mark to market losses in trading portfolios resulting from changes in factors such as credit ratings, share prices and solvency of counterparties; (iii) reduced ability to obtain capital from other financial institutions for Barclays Group’s operations; and (iv) lower levels of fixed asset investment and productivity growth overall.
ii) Process of UK withdrawal from the European Union
The uncertainty around Brexit spanned the whole of 2018, and intensified in the second half of the year. The full impact of the withdrawal may only be realised in years to come, as the economy adjusts to the new regime, but Barclays Group continues to monitor the most relevant risks, including those that may have a more immediate impact, for its business.
- Market volatility, including in currencies and interest rates, might increase which could have an impact on the value of Barclays Group’s trading book positions.
- Potential UK financial institutions’ credit spread widening could lead to reduced investor appetite for Barclays Group’s debt securities; this could negatively impact the cost of, and/or access to, funding. There is potential for continued market and interest rate volatility. This volatility could affect underlying interest rate risk value of the assets in the banking book and securities held by Barclays Group for liquidity purposes.
- A credit rating agency downgrade applied directly to Barclays Group, or indirectly as a result of a credit rating agency downgrade to the UK Government, could significantly increase Barclays Group’s borrowing costs, credit spreads and materially adversely affect Barclays Group’s interest margins and liquidity position.
- Changes in the long-term outlook for UK interest rates may adversely affect pension liabilities and the market value of investments funding those liabilities.
- Increased risk of a UK recession with lower growth, higher unemployment and falling UK house prices. This would likely negatively impact a number of Barclays Group’s portfolios, notably: higher Loan to Value mortgages, UK unsecured lending including credit cards and commercial real estate exposures.
- The implementation of trade and customs barriers between the UK and EU could lead to delays and increased costs in the passage of goods for corporate banking customers. This could negatively impact the levels of customer defaults and business volumes which may result in an increase in Barclays Group’s impairment charges and a reduction in revenues.
- Changes to current EU ‘Passporting’ rights may require further adjustment to the current model for Barclays Group’s cross-border banking operation which could increase operational complexity and/or costs.
- The ability to attract, or prevent the departure of, qualified and skilled employees may be impacted by the UK’s and the EU’s future approach to the EU freedom of movement and immigration from the EU countries and this may impact Barclays Group’s access to the EU talent pool.
- The legal framework within which Barclays Group operates could change and become more uncertain if the UK takes steps to replace or repeal certain laws currently in force, which are based on EU legislation and regulation (including EU regulation of the banking sector) following its withdrawal from the EU. Certainty around the ability to perform existing contracts, enforceability of certain legal obligations and uncertainty around the jurisdiction of the UK courts may be affected until the impacts of the loss of the current legal and regulatory arrangements between the UK and EU and the enforceability of UK judgements across the EU are fully known.
- Should the UK lose automatic qualification to be part of Single Euro Payments Area there could be a resultant impact on the efficiency of, and access to, European payment systems. In addition, loss of automatic qualification to the European Economic Area (EEA) or access to Financial Markets Infrastructure including exchanges, central counterparties and payment services could impact service provision for clients, likely resulting in reduced market share and revenue and increased operating costs for Barclays Group.
- There are certain execution risks relating to the transfer of Barclays Group’s European businesses to Barclays Bank Ireland Group. Technology change could result in outages or operational errors leading to delays in the transfer of assets and liabilities to Barclays Bank Ireland Group, and delayed delivery could lead to European clients losing access to products and service and increased reputational risk.