The market for food in the UK is highly competitive. From dining in style to a simple take-away, one of the key words when it comes to dining seems to be choice. Competitive prices and high quality are on offer, which is largely due to the sheer number of restaurants available to consumers. However, consolidation seems to be on the menu.
Nando’s is a well known restaurant and a popular eating destination on UK and Irish high streets, with more than 230 restaurants. This chicken restaurant group has made a £30 million bid for Clapham House, the company behind the Gourmet Burger Kitchen chain with 53 branches. Clapham’s shareholders were advised to accept the deal and on the 17th September 2010, it is reported that a deal was reached with Nando’s Group Holdings and its private equity owner Capricorn Ventures International. The 74 pence per share deal was met with disappointment by some analysts, who felt that the company was under-valued, despite failed attempts by Clapham House’s Board to persuade Capricorn to raise the offer price or find an alternative bidder.
The restaurant industry has suffered from the recession and especially by the weak economic recovery, so perhaps lower valuations are to be expected. Nando’s said:
‘As macroeconomic weakness has persisted in the UK, the trading environment for restaurant businesses in the UK has been difficult. This is evidenced by Clapham House’s vaolatile weekly trading performance.’
Nando’s intend to invest significantly in Clapham Houses’ businesses to reinvigorate their previous competitor. This may be essential, given the expectation that conditions in the UK will remain fragile, with consumer confidence staying low, as well as a somewhat untimely rise in VAT in January next year, which is almost certain to have an adverse effect on the restaurant business.
This take-over deal is not the first in the restaurant industry and nor is it likely to be the last, as the UK economy remains in a vulnerable state. The following articles look at this and over takeovers.
Nando’s to buy Gourmet Burger Kitchen for £30m BBC News (17/9/10)
UK restaurants serve up £50m in takeover deals Management Today, Emma Haslett (17/9/10)
Nando’s swallows Gourmet Burger Daily Mirror News, Clinton Manning (18/9/10)
GBK team plots next move after Nandos deal Telegraph, Jonathan Sibun (18/9/10)
Nando’s to buy Real Greek chain for £30m Independent, Alistair Dawber (18/9/10)
Mithcells & Butlers and Nando’s to feast on rival restaurant chains Mail Online, Ben Laurance (17/9/10)
GBK owner Clapham agrees to Nando’s offer Reuters (17/9/10)
Questions
- What type of takeover is Nando’s purchase of Clapham House?
- Why has the weak macroeconomic environment adversely affected the restaurant industry? What might be the impact of next January’s rise in VAT?
- Will Nando’s takeover (or indeed any other takeover in the restaurant industry) allow the company to prosper from the weak economic climate?
- In which type of market structure would you place the restaurant industry in the UK? Explain the characteristics of the market structure you choose and why you have placed the restaurant industry in it.
- How was the finance for the deal raised by Nando’s Holdings Group? What other sources of finance are available to firms for this purpose? What are the (a) advantages and (b) disadvantages of each?
- What other takeovers have occurred recently in the restaurant industry? What types of takeovers are they?
Under the Basel II arrangements, banks were required to maintain particular capital adequacy ratios (CARs). These were to ensure that banks had sufficient capital to allow them to meet all demands from depositors and to cover losses if a borrower defaulted on payment. Basel II, it was (wrongly) thought would ensure that the banking system could not collapse.
There were three key ratios. The first was an overall minimum CAR of 8%, measured as Tier 1 capital plus Tier 2 capital as a percentage of total risk-weighted assets. As Economics 7th edition page 509 explains:
Tier 1 capital includes bank reserves (from retained profits) and ordinary share capital, where dividends to shareholders vary with the amount of profit the bank makes. Such capital thus places no burden on banks in times of losses as no dividend need be paid. What is more, unlike depositors, shareholders cannot ask for their money back. Tier 2 capital consists largely of preference shares. These pay a fixed rate of interest and thus do continue to place a burden on the bank even when losses are made (unless the bank goes out of business).
Risk-weighted assets are the value of assets, where each type of asset is multiplied by a risk factor. Under the internationally agreed Basel II accord, cash and government bonds have a risk factor of zero and are thus not included. Inter-bank lending between the major banks has a risk factor of 0.2 and is thus included at only 20 per cent of its value; residential mortgages have a risk factor of 0.35; personal loans, credit-card debt and overdrafts have a risk factor of 1; loans to companies carry a risk factor of 0.2, 0.5, 1 or 1.5, depending on the credit rating of the company. Thus the greater the average risk factor of a bank’s assets, the greater will be the value of its risk weighted assets, and the lower will be its CAR.
The second CAR was that Tier 1 capital should be at least 4% of risk weighted assets.
The third CAR was that equity capital (i.e. money raised from the issue of ordinary shares) should be at least 2% of risk weighted assets. This is known as the ‘core capital ratio’.
Before 2008, it was thought by most commentators that these capital adequacy ratios were sufficiently high. But then the banking crisis erupted. Banks were too exposed to sub-prime debt (i.e. debt that was excessively risky, such as mortgages on property at a time when property prices were rapidly declining). Much of this debt was disguised by being bundled up with other securities in what were known as collateralised debt obligations (CDOs). On 15 September 2008, Lehman Brothers filed for bankruptcy: the largest bankruptcy in history, with Lehmans owing $613 billion. Although its assets had a book value of $639, these were insufficiently liquid to enable Lehmans to meet the demands of its creditors.
The collapse of Lehmans sent shock waves around the world. Banks across the globe came under tremendous pressure. Many held too much sub-prime debt and had insufficient capital to meet creditors’ demands. As a result, they had to be bailed out by their governments. Clearly the Basel II regulations were too lax.
For several months there have been discussions about new tighter regulations and, on 12 September 2010, central bankers from the major countries met in Basel, Switzerland, and agreed the Basel III regulations. Although the overall CAR (Tier 1 and 2) was kept at 8%, the Tier 1 ratio was raised from 4% to 6% and the core Tier 1 ratio was raised from 2% to 4.5%, to be phased in by 2015. In addition there were two ‘buffers’ introduced.
As well as having to maintain a core Tier 1 ratio of 4.5%, banks would also have to hold a ‘conservation buffer’ of 2.5%. “The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. While banks are allowed to draw on the buffer during such periods of stress, the closer their regulatory capital ratios approach the minimum requirement, the greater the constraints on earnings distributions.” In effect, then, the core Tier 1 ratio will rise from 2% to 7% (i.e. 4.5% minimum plus a buffer of 2.5%).
The other buffer is a ‘countercyclical buffer’. This will be “within a range of 0% – 2.5% of common equity or other fully loss absorbing capital and will be implemented according to national circumstances.” The idea of this buffer is to allow banks to withstand volatility in the global economy. It will be phased in between 2016 and 2019.
The Basel III agreement will still need to be ratified by the G20 countries meeting at Seoul on 10 and 11 November this year. That meeting will also consider other elements of bank regulation.
So will these extra capital requirements be sufficient to allow banks to withstand any future crisis? The following articles discuss this question.
Articles
Global bankers agree new capital reserve rules BBC News (12/9/10)
Q&A: Basel rules on bank capital – who cares? BBC News, Laurence Knight (13/9/10)
Basel III and Sound Banking New American, Charles Scaliger (17/9/10)
Wishy-washy rules might come back to haunt regulators Financial Times, Patrick Jenkins (18/9/10)
Basel III proposal released Newsweek, Joel Schectman (17/9/10)
New Bank Rules May Not Prevent More Meltdowns FXstreet, Henrik Arnt (16/9/10)
Basel III CBS Money Watch, Mark Thoma (14/9/10)
Basel III: To lend or not to lend Investment Week, Martin Morris (16/9/10)
Taming the banks The Economist (16/9/10)
Basel’s buttress The Economist (16/9/10)
Do new bank-capital requirements pose a risk to growth? The Economist, guest contributions
Myners: New rules ‘ignore bank liquidity’ BBC Today Programme, Robert Peston and Lord Myners (18/9/10)
Official press releases and documents
Group of Governors and Heads of Supervision announces higher global minimum capital standards Bank for International Settlements Press Release (12/9/10)
The Basel iii Accord Basel iii Compliance Professionals Association (BiiiCPA)
Details of the new capital requirements Bank for International Settlements
Details of the phase-in arrangements Bank for International Settlements
Questions
- What impact will a higher capital adequacy ratio have on banks’ behaviour?
- For what reasons may the Basel III regulations be considered too lax?
- When there is an increase in deposits into the banking sector, banks can increase loans by a multiple of this. This bank deposits multiplier is the inverse of the liquidity ratio. Is there a similar bank capital multiplier and, if so, what determines its size?
- Why will Basel III be phased in over a number of years? Is this too long?
Economists are famous for disagreeing – as, of course, are politicians. And there is a lot of disagreement around at the moment. George Osborne is determined to cut Britain’s large public-sector deficit, and cut it quickly. This, argues the Coalition government and many economists, is necessary to maintain the UK’s AAA sovereign credit rating. This, in turn, will allow interest rates to be kept down and the international confidence will encourage investment. In short, the cut in aggregate demand by government would be more than compensated by a rise in aggregate demand elsewhere in the economy, and especially from investment and exports. By contrast, not cutting the deficit rapidly would undermine confidence. This would make it more expensive to borrow and would discourage inward investment.
Not so, say the opposition and many other economists. A contractionary fiscal policy will achieve just that – an economic contraction. In other words, there is a real danger of a double-dip recession. Far from encouraging investment, it will do just the opposite. Consumers, fearing falling incomes and rising unemployment, will cut back on spending. Businesses, fearing a fall in sales, will cut back on investment. Economic pessimism, and hence caution, will feed on themselves.
So who are right? The first two blogs by Stephanie Flanders, the BBC’s Economics Editor, look at the arguments on both sides. The third attempts to sum up. The other articles continue the debate. For example, the link to The Economist contains several contributions from commentators on either side of the debate. See also the earlier posting on this site, The ‘paradox of cuts’.
Articles
The case for Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (7/9/10)
The case against Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (8/9/10)
Austerity plans: Where do you stand? BBC News Blogs, Stephanomics, Stephanie Flanders (10/9/10)
Are current deficit reduction plans likely to boost growth? The Economist debates, various invited guests
Debt and growth revisited Vox, Carmen M. Reinhart and Kenneth Rogoff (11/8/10)
Leading article: Mr Osborne should prepare a Plan B Independent (13/9/10)
Shock fall in UK retail sales adds to fears of double-dip recession Guardian, Larry Elliott (16/9/10)
Chancellor accused of £100bn economic growth gamble by Compass Guardian, Larry Elliott (18/9/10)
Double-dip recession: bulls and bears diverge over future economic prospects Guardian, Phillip Inman (16/9/10)
Speech by Mervyn King to TUC Congress TUC (15/9/10)
Barber, Blanchflower and the fake debate on double dip The Spectator, Ed Howker (14/9/10)
Confidence data
Consumer confidence Nationwide
ICAEW / Grant Thornton UK Business Confidence Monitor (BCM) ICAEW
Business and Consumer Surveys Economic and Financial Affairs, European Commission
Questions
- Summarise the arguments for the Coalition government’s programme of rapidly reducing the public-sector deficit.
- Summarise the arguments against the Coalition government’s programme of rapidly reducing the public-sector deficit.
- What factors are likely to determine whether there will be a double-dip recession as a result of the austerity programme?
- Why is it very hard to predict the effects of the austerity programme?
- How effective is an expansionary monetary policy likely to be in the context of a tightening fiscal policy?
- How important are other countries’ macroeconomic policies in determining the success of George Osborne’s policies?
- How similar to or different from other recessions has the recent one been? What are the policy implications of these similarities/differences?
For the past three years the Japanese yen has been appreciating against the US dollar and many other currencies. From the end of June 2007 to 14 September 2010, the yen appreciated from ¥100 = $0.81 to ¥100 = $1.20 (a 48% appreciation). Over the same period the yen exchange rate index rose from 113.3 to 172.4 (a 52% appreciation). The rising yen has been impeding Japan’s recovery as it has made its exports more expensive, while, at the same time, making imports cheaper and thus making it harder for domestic firms to compete.
Until 14 September 2010, the yen was freely floating. But on 15 September, the Japanese central bank decided to intervene by selling yen and buying dollars and other currencies.
But why had the yen risen so strongly? There are four main reasons.
The first is the persistent Japanese trade surpluses, partly stimulated by falling costs of production in Japan.
The second is the unwinding of the carry trade. Before the banking crisis of 2007/8, many banks and other financial institutions borrowed yen, given the low interest rates in Japan, and used the yen to purchase dollars and pounds, given the much higher interest rates in the USA and the UK. The effect of this ‘carry trade’, as it was known, was to drive up the exchange rates of the dollar and sterling and drive down the value of the yen. This encouraged further speculation as people sold yen in anticipation of further depreciation and purchased dollars and sterling in anticipation of further appreciation. With the banking crisis, however, short-term financial flows decreased and the current account became more important in determining exchange rates. The carry trade began to unwind and people began selling dollars and sterling and buying yen. What is more, towards the end of 2008, interest rates were reduced substantially in the USA and the UK in order to stimulate aggregate demand. The interest rate differential between Japan and the USA and UK virtually disappeared. This further encouraged the purchase of yen and the sale of dollars and sterling as carry trade investors began paying back their loans to Japan.The third reason for the appreciation of the yen is the actions of the Chinese who have used their surpluses to buy other currencies: originally mainly dollars, but increasingly yen.
The fourth reason is speculation. As the yen has risen, so increasingly people have bought yen in anticipation of further appreciation. But, of course, this speculation has brought about the very effect the speculators anticipated. Such speculation can be very powerful, given that some $4 trillion goes across the foreign exchange markets every day (see The inexorable growth of FOREX).
So will the intervention by the Bank of Japan be successful in causing the yen to depreciate? Or will the forces that drove up the yen prove impossible to resist? The following articles consider this question and also look at the factors that caused the yen to appreciate and its effects on the Japanese economy.
Articles
Japan’s $21b move to weaken yen may be futile Sydney Morning Herald (16/9/10)
Japan acts to weaken surging yen Guardian, Larry Elliott and Graeme Wearden (15/9/10)
Q+A: How is Japan judging success in yen intervention? Reuters, Hideyuki Sano and Charlotte Cooper (17/9/10)
Tokyo action puts brake on yen Financial Times, Peter Garnham (17/9/10)
It’s hard to keep a strong yen down CTV, Canada, Brian Milner (16/9/10)
Firm stance on yen stressed / Govt, BOJ strike decisive pose, but drastic action still required Daily Yomiuri, Japan, Tadashi Isozumi and Yomiuri Shimbun (16/9/10)
Bernanke Shadow of Easing Limits BOJ Success With Yen Weakness Bloomberg, Ron Harui and Joshua Zumbrun (17/9/10)
The Bank Of Japan Is Spitting In The Wind Wall Street Journal blogs: The Source, Nicholas Hastings (16/9/10)
Japan intervenes in markets to combat rising yen BBC News, Mariko Oi (15/9/10)
Q&A: What’s moving the Japanese yen? BBC News (15/9/10)
Currency intervention’s mixed record of success BBC News, Russell Hotten (16/9/10)
Yen intervention: Because I Kan The Economist (16/9/10)
Beggar, then sneakily enrich, thy neighbour The Economist (15/9/10)
The yen and gold The Economist, Buttonwood (15/9/10)
Data
Dollar/yen exchange rate X-rates.com
Statistical Interactive Database – interest and exchange rates data Bank of England
Currencies BBC News
Currency converter Yahoo Finance
Questions
- Why has the Japanese yen appreciated so much over the past three years?
- What will be the effect of the Bank of Japan’s exchange market intervention on Japanese money supply? What will determine the size of this effect?
- Why might the Bank of Japan’s actions have been influenced by the anticipation of further quantitative easing by the US Federal Reserve Bank?
- What factors determine the likely success of foreign exchange market intervention by central banks?
- What will determine how speculators will react to the Bank of Japan’s actions?
- Discuss the following quote from the second The Economist article above: “A bit of inflation in Japan wouldn’t just be a good thing. It would be a really, really great thing. And if other countries react to Japan’s intervention by attempting to print and sell their own currencies in order to toss the deflationary potato to someone else, well then so much the better.”
- If all countries seek to achieve export-led growth, is this a zero-sum game?
- Why has the price of gold been rising?
What is the future of the Royal Mail? One thing for certain is that it needs an injection of money, which has led the government to consider either privatisation of the Royal Mail or selling it. Over the past years, we have seen continued strikes by the postal service in response to proposed changes in working practices. Mr. Cable commented that:
‘Royal Mail is facing a combination of potentially lethal challenges – falling mail volumes, low investment, not enough efficiency and a dire pension position.’
However, there are concerns that the privatisation or sale of the Royal Mail could lead to higher prices, job losses and further pension problems. The transfer of the Royal Mail to the highest bidder could shift the pension deficit, currently standing at £13.3 billion, to the taxpayer, potentially costing each taxpayer £400. The choice for the public is stark: either lose the right to send a letter anywhere in the UK for the same price or take on postal workers’ pensions.
Expecting massive opposition from the Communication Workers Union (CWU), Ministers are looking to pursue an arrangement similar to that of John Lewis, whereby staff are given shares in the company. This will give the staff an incentive to perform well to improve the performance of the company and hence increase their future dividend. Read the following articles and then try answering the questions that follow.
Royal Mail is to be privatised, government confirms BBC News (10/9/10)
Royal Mail sell-off is confirmed BBC News, Hugh Pym (10/9/10)
Royal Mail privatisation backed Press Association (10/7/10)
Royal Mail sale could cost £400 per home as taxpayers set to fund £13.3 billion pension deficit Mail Online, James Chapman (10/9/10)
Royal Mail pension plan challenged by regulator BBC News, Ian Pollock (30/7/10)
Ministers consider offering 20 per cent of shares in Royal Mail to staff Telegraph, Christopher Hope (10/9/10)
Cable to privatise ‘inefficient’ Royal Mail Independent, Cahal Milmo and Alistair Dawber (11/9/10)
Royal Mail revolution needed, say bankers Telegraph, Louise Armitstead (10/9/10)
Questions
- What are the problems that the Royal Mail is facing? Why have they occurred?
- What are the arguments for and against privatisation of the Royal Mail?
- How might privatisation lead to job losses and higher prices?
- What type of business arrangement does John Lewis have? Explain why this may improve overall performance of the company?
- If the pension deficit is passed on to the government, why will it cost the taxpayer? Is such an arrangement (a) efficient (b) equitable? Explain your answer.