Vernon Hill, chairman of Metro Bank Plc, gestures as he speaks during an interview at the bank's Southampton Row branch, in London, U.K., on March 23, 2015. Hill is expanding in some of the world's most expensive real estate while the U.K.'s four biggest banks close branches across the country and dole out compensation for selling insurance to people who didn't need it. Photographer: David Levenson/Bloomberg
© Bloomberg

It’s easy to make fun of Vernon Hill, which does not make it wrong. The Metro Bank co-founder, who this week stepped down as chairman with immediate effect, was never a figure who invited being taken completely seriously.

All-American showmanship and down-home folksiness had made Mr Hill an outlier in the staid world of British retail banking. So did his ego. Within two years of Metro opening its first UK branch, Mr Hill had published an inspirational secrets-of-my-success book — Fans! Not Customers — that delivers cornball wisdom and random italicisation on every one of its 156 gosh-darn pages.

Even this week’s abrupt exit had the kind of vaingloriousness that invites mockery. Mr Hill will remain “chairman emeritus” to recognise his “extraordinary contribution” to the bank. A reminder that under his chairmanship Metro discovered a catastrophic error in its loan book, botched a fundraising, tore up its business plan and lost 90 per cent of its value versus the 2016 flotation price. The joke writes itself.

But the story of Metro has more than hubris meets nemesis. The bank’s struggle, along with the failure of a whole generation of UK challenger banks to beat the incumbents, has been as much about the consequences of misguided regulation as bad management. It was never a level playing field.

Well-intentioned rules from Europe were what sealed Mr Hill’s fate. Banks had been told to issue expensive loss-absorbing debt known as “minimum requirement for own funds and eligible liabilities”, or MREL, to prevent a repeat of the 2008 government bailouts. But while eurozone regulators put the MREL shock absorber on lenders with assets over €100bn, The Bank of England set its requirement much lower, at over £15bn.

The burden proved disproportionately harsh on start-up lenders that lacked experience in debt capital markets, not least because they had no existing senior unsecured bonds to roll into MREL debt. Metro’s failure to find buyers for £300m of MREL bonds in September was the final straw for many investors. The chairman announced his departure a week later.

Challenger banks had also been put at a disadvantage when measuring credit risks. Big UK lenders use their own models when calculating risk-weighted assets on their mortgage and corporate loan books. Their smaller rivals, at least until they can be trusted, are given a one-size-fits-all model that requires more capital. Metro, according to analysts, will have to wait until at least 2021 to be allowed to use its own risk methodology. Virgin Money owner CYBG was given the right just a year ago, after its Clydesdale Bank and Yorkshire Bank subsidiaries had been trading for 180 years and 159 years respectively.

Then there was the BoE’s Term Funding Scheme (TFS), a stimulus programme launched in 2016 to cushion banks from the effects of an emergency interest rate cut in the wake of the Brexit vote. The immediate effect was to halve profit margins on mortgages and kick off a price war the challengers could not win.

Because of UK rules that separated domestic retail operations from other activities, the big High Street lenders were awash with ringfenced deposits that could be poured into the mortgage market. Once the BoE’s bung ran out, the challengers — unable to match the incumbents’ low funding costs and scale efficiencies, as well as lacking their back-books of docile customers on higher interest rates — had a tough choice: price new loans uncompetitively or step out of the market altogether.

Metro chose the former path, even if its lending book pales in comparison to that of larger rivals. It brought in £83m of gross new residential mortgage lending in the three months to the end of September this year. Royal Bank of Scotland’s figure for the same period was £8.6bn.

By the end of next year, around £120bn of the cheap TFS funding needs to be refinanced. The likes of NatWest or Lloyds should have no problem rolling their requirements into the wholesale markets while still using ringfenced cash in pursuit of mortgage market share. For their smaller rivals, replacing the BoE’s free money supply is yet another headwind.

There is no doubt that Metro got things wrong, including its own accounts. Nevertheless, suggesting the model was always doomed to fail may be unfair. Mr Hill’s belief in the halo effect of service quality is not that different from the sales pitch offered by a new breed of fintech challengers like Monzo and Starling, although their message is directed towards millennials rather than baby boomers. Metro’s much ridiculed branch rollout was meant to be self-funding, at least in part by offering safety deposit boxes, another banking niche abandoned by the big lenders as an anachronism. The free dog biscuits, the change-counting machines, the cartoon mascots: it was all deeply unfashionable but not entirely irrational.

Perhaps Mr Hill’s biggest mistake, then, was to believe a decade ago that the UK banking regulators were keen on encouraging competition. Everything that has happened in the interim has suggested otherwise.

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