The Bankwatch

Tracking the consumer evolution of financial services

Posts Tagged ‘leverage

Conservatives propose radical changes to banking regulation in UK

There are some dramatic proposals contained in the upcoming white paper from the Conservatrive opposition [UK] this week. They make sense and go to the core of the flexibility that allowed banks to become too speculative. They address leverage, and the investment banking/ retail banking integration challenge. The Conservatives are larely expected to win the next election, sometime in the next 12 months.

Tories say break up the big banks | The Times

He will be clear, however, that the Bank should have powers to order banks and other financial institutions to hold more capital when times are good, so that they are well-placed to cope with the losses that arise during downturns.

These counter-cyclical capital requirements, one version of which was the so-called dynamic provisioning used for Spain’s banks, are seen by Mervyn King, the Bank governor, as an essential part of the “macro-prudential” toolkit.

The most controversial part of Osborne’s proposals, however, will be his response to the “too big to fail” problem for banks. He is expected to back King’s view, set out last month, that large and complex banks that combine retail banking with risky investment banking, should either not have their deposits guaranteed by the taxpayer or be discouraged by even larger capital requirements.

Osborne will make clear that he believes some banks were allowed to become too big. He will give the Bank the powers to intervene – and, if necessary, break up – banks whose size and structure threatens financial stability.

Written by Colin Henderson

July 19, 2009 at 00:32

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

What does recovery mean for Banks?

Banks are at the centre of the economy.  Business and consumers conduct their day to day business using money and they do this through banks.  Stating the obvious you may say?  This is why I study the economy so closely and try to understand how it will look in the future, because that has a direct relation to how banks will look in that future.

We are in a crisis of debt.  It is a debt crisis because consumers and businesses are over-leveraged.  Their debt is too high relative to todays asset values.  Asset values have decreased by 25 – 60% in the West, whereas debt has reduced only minimally.

So what do we see around us that offer substantive clues to our near term future for banks?

  • US economy reducing at annual rate of 6.1% – this has to be contrasted to growth rates of 2 – 3% pre crisis, so thats an almost 10% shift being experieinced
  • Lithuania today seeing a 12% reduction in its economy
  • Germany seeing 5% – 6% and talk of rioting on the streets, which of course will do no good except create panic
  • Citibank and Bank of America today finally wisening up to the reality that they cannot grow out of their leveraged position – they must contract out of it by selling stuff
  • corporate jets becoming an embarrassment rather than a status symbol
  • Allens & Overy (lawyers in the City) introducing a ‘cull’ of 10%
  • 80 – 100% growth in managerial and professional unemployment (UK)
  • General Motors in Canada cutting dealerships from 794 down to 400 – 400 within one year

These headlines are all point in one direction.  Less is the new reality.  No-one knows precisely where the new balance will level off, but it is certainly going to be at a level less thn we saw at the peak in 2007.

A smaller economic base results in less of many other things that probably still have to happen;  less restaurants, real estate agents, accountants, grocery stores, plumbers, construction workers, and of course bankers and banks.

Relevance to Bankwatch:

Operating in this new environement will require new thinking and recognition of new opportunities.  This will be the time (for banks) to not just accept internet but to insist on internet as a core component of the business to drive efficiencies.  It will require fresh looks at old ideas that were squandered away and hidden by the excesses of the good times, eg:

  • # of branches required?
  • style of branches required- which services will be offerred?
  • what is the the role of tellers in the new operating model?
  • is it time to eliminate cheques ?
  • is it time to bring commercial banking into the and up to the same degree of automation as consumer banking?
  • Why is business banking still being done by cheques and deposit books?
  • What is the role of Head Office?  How many are required to invent bank accounts, mortgages and loans?

In a smaller and more efficient world, new competitors will be prodding away at banks’ business model.  I watched many of the presentations yesterday at FinovateStartup09 and was struck by how they all in some way chipped away a part of banking from banks.  Whether it is Tempo and their de-coupled debit card, or Wesabe and Micronotes pro-actively helping consumers spend wisely, or Prosper and Lending Club introducing “Securitization 2.0′ (online secondary markets with clear line of sight between debtor and creditor),  the coming of Web 3.0 is imminent and in a form that banks may not expect nor be prepared for unless they act now.

Bank capital levels around the world are low and sufferring

The IMF report had a spreadsheet in the appendix with bank capital levels around the world.

While it has individual countries, I summarised into this chart.  The data shows Capital as a percentage of Assets so higher is good, lower is bad.

Note the negative trends in most except Canada, and this is based on the latest data to end of 2008.  Use the thumbnail for a larger version that is clearer.



Written by Colin Henderson

April 21, 2009 at 11:46

Posted in regulation

Tagged with , ,

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