Saturday, June 23, 2012

Capital ratio “improvements” and other bank regulation nonsense

A bank is essentially like a balance scale. One one side you have all the money that is owed to the bank (loans), and on the other side is all the money that the bank owes other people (deposits).

How healthy a bank is depends on how much more the “loans” side weighs than the “deposits” side. As long as the loans are worth more than the deposits, the bank is safe from a bank run, because even if it cannot sell the loans right away, the central bank will give it the cash it needs to pay off depositors that take out their money.

If the bank is unhealthy, there are only four real fixes:

  1. Raise money by selling shares (since normal shares never need to be paid back).
    • Raising new money impossible to do honestly, since no sane investor would buy shares that are worth less than zero. Eg if the gap between assets and liabilities is $1 billion, and the bank raises $1 billion from investors, the shares of the bank are now worth $0.
    • If you have preferred shareholders, force them to become common shareholders. (This is why buying preferred bank shares is stupid, you have all the same downsides as common shares, but your upside is capped).
  2. Find someone to buy your loans or other assets at above market value.
  3. Higher profits (since real profits don’t need to be paid back)
    • Takes a long time, since you can only soak your customers for so much. (Bye bye La Caixa!)
  4. Liquidate the bank. The uninsured depositors take the hit and the government for the insured amount.

If the bank starts selling off assets at or below market value, it does nothing to improve the situation, because the distance between assets and liabilities stays the same. The same is with any kind of fusion or other fancy maneuver.

Eg if I sell a piece of jewelry to pay off my debts, I am not suddenly richer, since my net wealth is still the same (and might even be worse off if I had to sell it at below market value).


Anonymous said...

Just curious...what (Spanish) bank are you with :-)?

santcugat said...

Right now we're still using CAM (historical reasons and the fees are low). Not for any savings though, just the old salary and receipts. Any savings go directly overseas.