The Bankwatch

Tracking the consumer evolution of financial services

How can a bank with over 2 trillion in assets fail?

econnov20th1The headlines surrounding Citi are reminiscent of a wolf pack circling its prey. But how can a bank such as them fail? And how can it go from making a billion dollar offer to purchase Wachovia to failure?

Citigroup stock drops to 13-year low, fear grow | Reuters

NEW YORK (Reuters) – Citigroup Inc faced a crisis of confidence on Wednesday as investors questioned the survival prospects of the U.S. banking giant, and its shares tumbled 23 percent to a 13-year low.

The second-largest U.S. bank by assets has been reeling on concerns that mounting losses from credit cards, mortgages and toxic debt could overwhelm its efforts to slash costs and add deposits. Last month, Wells Fargo & Co dealt a blow by derailing Citigroup’s bid to buy Wachovia Corp.

Some facts, and I go back to my earlier posts on bank leverage.

Total Assets: $ 2,050 Bn

Total Liabilities $ 1,924 bn

Equity $ 126 bn

Normal Net income (2006) $21 Bn

Lets do the math here:

debt to equity = 15 :1 – on the high side even for banks. Capital is 6.2% of assets. Basel 2 requires 9% + I believe so they are already on the wrong side of that barometer.

Scenario: if their losses are $50 bn or more then equity is reduced to $76 bn. Ratios become 25 :1 and 3.7%.

In any other industry, this is called bankrupt.

Relevance to Bankwatch:

Unfortunately this calculation could be performed with similar results on too many large banks.  The reality is that the government ownership of certain banks is the only way for them to make it through this crisis and have any opportunity to exist and plan on the other side.  This will also curtail innovation.

Perfect time for financial system alternatives, and I hope the banking regulators see the irony in that, and let it happen.

Written by Colin Henderson

November 21, 2008 at 13:37

5 Responses

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  1. Yes, essentially the US money system is designed such that profits are privatized and losses are socialized. It’s not something that’s the result of the recent greed (although greed helped bring it to crazy levels this time), but simply the result of the 1913 Federal reserve act and Basel agreements which allowed to put things off balance sheet.

    Time for financial system alternatives indeed. I’m putting an s because I really hope we will have an Internet-like money system – decentralized and resilient to failure – rather than an AOL-like money system.

    Most importantly, “money” must be taught in high-schools.

    Guillaume Lebleu

    November 21, 2008 at 13:58

  2. Nice comment Guillaume – thanks for stopping by and the future oriented insight.


    November 21, 2008 at 14:53

  3. Colin,
    The Basel calculation is risk weighted assets, and several liabilities and elements of quasi-capital count as capital for Basel purposes. A 6% raw capital figure, as you have calculated, probably equates to about 10 or 11% Basel I calculated capital. They have not (yet) begun to calculate capital on a Basel II basis.
    Additionally, the magic number for Basel purposes is 8%. The regulators would be expected to move in if the Basel calculated capital was to look like dropping below that. Even at 3.7% they would only be (too) thinly capitalised, not bankrupt.


    November 21, 2008 at 20:16

  4. Andrew .. thanks for that. I hoped someone would stop by on this. Re not bankrupt, I was using normal accounting criteria as opposed to Basel, but I certainly take your point.

    Again much appreciated.


    November 22, 2008 at 00:27

  5. what’s the off-balance sheet exposure for Citi?


    November 24, 2008 at 01:54

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