The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘‘financial utilities” “the great unwinding”

Bank deposits – the hidden risk associated with government guaranteed deposits


The focus on bank financial strength is generally on the lending side of the business and the potential for bad debts.  Here is another view, and something that drives some banks to make ever riskier loans to produce enough revenue to pay for their deposits.

For Banks, Wads of Cash and Loads of Trouble | NY Times

The 79 banks that have failed in the United States over the last two years had an average load of brokered deposits four times the national norm

But the hot money also came with a high cost. To lure the money from brokers, banks typically had to offer unusually high rates. That, in turn, often led them to make ever riskier loans, leaving them vulnerable when the economy collapsed. Magnet failed early this year and Security Bank is barely hanging on.

When we assess leverage it is not just the quality of the assets, it is also the cost of the liabilities, which is what deposits are to banks – liabilities with an associated cost.

It is ironic that those deposits that banks are gathering across the US from other than their home state at high rates, are also FDIC insured.  So the US taxpayer has been passively promoting banks to take undue risks by gathering high cost insured deposits to fund their mortgage and loan growth.

This is just another element to take into account for The Great Unwinding of leverage in the financial system.  The deleveraging that takes place will result in smaller institutions, and much less value attributed to deposits in cash, due simply to a supply that far outstrips demand. The outcome will depend on whether the regulators institute limits on FDIC insurance, limits on brokerage or some hybrid of those.

Relevance to Bankwatch:

One more blow against the old system.  A banking business model based purely on arbritrage on interest is not viable, and highly susceptible to risk associated with leverage.  This leads to two conclusions:

  1. Regulation: The unintended consequences of regulation such as deposit insurance are complex, and need to be considered by the regulators.  Those unintended consequences could be more expensive in the long run through higher taxes, than the immediate apparent benefit.
  2. Bank models: Banks have historicaly been arbiters of money between lenders and borrowers.  Non Interest revenue from fees has been long considerd considered icing on the cake from interest revenue – essential icing, but nonetheless icing.  The new world is smaller and requires efficiency.  What if a banking model were built on fee revenue first?  This would require products and services that are seen as valuable by consumers, and it would drive different approaches than investment in expensive branches, ATM networks, and staff.

PS:  To provide a sense of scale of the problem, a back of the envelope calculation on some Canadian banks where I have an idea about the customer and staff numbers produces a customer to employee ratio of 150:1.  A similar cacluation on core banking (primary chequing with that bank) customers to employee ratio brings an incredible 50:1.  This hardly suggests that the investments in technology, branches and infrastructure over all the years has been effective.  Banks efficiency has been hidden from view by the growth in the financial system.  Much more to come on this.

Written by Colin Henderson

July 4, 2009 at 22:20

Bank nationalisation by a thousand cuts is distracting us from the root problem


In the series “The Great Unwinding” last week two types of banks, Financial Utilities and Risk Takers were highlighted to appear.  This direction received strong support this weekend with Alistair Darlings order to perform a complete review of bank practices.

The review is the not so thin edge of a large wedge when the ramifications are considered.

The chancellor said on Sunday that the review would look at risk management by boards including how pay affects risk taking; it would also look at the way boards operate and the role of institutional investors.

Mr Osborne (Shadow Chancellor)  added: “The party is over for the banks. You can’t go on paying yourselves 20 times what a heart surgeon earns.”

Last October I wrote that RBS and Lloyds/ HBOS were effectively nationalised by the actions taken by the Government and since copied in other jurisdictions, mainly US.  You will recall that the original intent promoted by TARP in US was to carve off the toxic loans into a “bad loan bank” which would have had the role of managing those loans.  That approach would have allowed banks to continue to operate as smaller banks, with adequate capital.  Additional controls on operations of banks to ensure stabiity of the system  could have been implemented through appropriate regulation.  Credibiilty and confidence in the banking system would have been restored quicker because the doubts about asset quality would be removed and presumably the remaining assets (bank loans) would have been operating normally and since there would have been less assets (investment) the capital base would have been relatively stronger.

However the British Government went straight to their socialist roots and went down the ownership route taking significant stakes.  This is akin to taking a tiger by the tail – once you start you cannot stop as they are now finding.  The rapidity which the US followed suit surprised me as they took stakes in the banks too.  And just last week Obama found himself regulating bank executive pay limiting it to $500K.  Neither government should be surprised by this.  Of course their is popular outrage at bank executive pay and bonuses, and of course that outrage is directed at … the owners!  The owners are the government who are politicians first, so now we have the politicians running around managing messages such as bankers bonuses. Once government starts with a review of internal governance and practices it is impossible to retreat from that slippery slope.  Each item in the review will drive out sets of others that once viewed in the public eye will bring out additional political issues that will require additional political influence, and the snowball will grow and grow.

I am not agreeing or disagreeing with bankers bonuses.  I am suggesting that that debate is irrelevant and distracting when it comes to solving the crisis of confidence in the banking system that is created by assets that are not accurately valued – in fact the doubts are such that a value of zero is the only rational value and this is displayed in the stock prices of those banks.

In fact nationalisation may be an appropriate approach even though I would not pick it.  However the half in/ half out situation that the banks are in now is doing irreparable harm to those banks and to the economy both through failure to address the central issue of asset valuation, and through ensuring politically oriented non-management by those half in banks.  Those same banks are destined to the category of Financial Utilities.

One a separate note,  it probably is too late to create the bad bank now – and as Niall Ferguson recently wrote, that bank already exists.  [emphasis mine]

Now the talk is of a new “bad bank” to buy the toxic assets that the Troubled Asset Relief Program couldn’t cure. No one seems to have noticed that there already is a “bad bank.” It is called the Federal Reserve System, and its balance sheet has grown from just over $900 billion to more than $2 trillion since this crisis began, partly as a result of purchases of undisclosed assets from banks.

Written by Colin Henderson

February 8, 2009 at 13:20

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