Archivo del April, 2013

Capital vs Capital

Back to European banks´ capitalization levels.

Deutsche Bank is calling itself “one of the best capitalized banks in our global peer group”.

They say that because their regulatory capital ratios are indeed quite high: 12% Core Tier 1, 16% Tier 1

This means DB already complies, by far, with the new “stringent” Basel III requirements (7-9.5% Core Tier 1, but only by 2019).

So what´s all this talk about Euro banks (and DB in particular) being way undercapitalized, especially with regards to US counterparts? Why is JP Morgan´s boss screaming to the high heavens about such discrepancies, if they do not apparently exist?

Well, those ratios are calculated over Risk Weighted Assets (RWA), not actual assets. And RWA (a kind of “voodoo”) can represent just a tiny fraction of actual assets. So a very high Capital over RWA ratio can in fact stand for a very low Capital over Assets ratio. Of course, what matters for bank solvency is the latter (i.e. how fast can my equity be wiped out if assets fall in value).

What´s DB true leverage ratio? Q1 2013 on-balance-sheet equity is just 2.75% of total on-balance-sheet assets. If those assets drop by 2.75%, DB is insolvent.

Which capital number do you trust best?

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A New Adventure Begins

We´ve kick-started a new academic adventure: the Finance Lab Workshop MBA elective course. About 20 brave and pioneering souls have decided to venture into unknown territory to sample what promises to be an innovative and enlightening experience. This is a course where students are in command (under some “adult” supervision). The course truly tests their ability and desire to learn in a self-driven fashion. It´s very dynamic and attuned to real world urgencies. It should help refine and polish students´ oral and written communication skills. There are no homeworks or exams. Just in-class in-group presentations, all leading to a final report. You face no stringent deadlines on very specific assignments, but you must prove yourself every week. Self-directed dynamic demanding work that aims to tackle some pressing real-life theme? Doesn´t sound too different from what you should expect on the job out there.

For this year we have selected Sovereign Debt as the central topic. I don´t need to elaborate on its utter relevance and immediacy.

The first in-class presentations went really well and I have a feeling we are all going to learn a lot from each other. This course encapsulates a lot of the things that can make ESADE a great place to study and experience: diversity (we have students from all over, from Vietnam to Japan, from the US to Saudi Arabia, from Brazil to Hungary), freshness (very “unstructured”, very new, very individualized, very “unconventional”), and fearless innovation (I don´t think many schools offer such an opportunity, especially so early in the MBA; and it´s part of the overall Finance Lab, pretty unique in itself certainly)

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Are All Euro Banks Insolvent?

Let´s not forget that the problem with Cyprus is first and foremost a banking problem. Which takes us to the issue of banks blowing up because they have very little capital. When your capital is depleted by losses you become insolvent. If no one steps in, it´s good bye time.

So Cypriot banks will get a bail out plus liabilities are reduced via haircuts.

Everybody and theit brother are wondering about spillover effects over other Euro banks. As if Euro banks needed Cyprus to get in touble before they could get in truble. They were already in trouble. For a long long time. Basically, they haven´t had a lot of (real) capital in a long while.

Many of the most relevant Euro banks essentially have no equity capital (2-4% of total on-balance sheet assets, i.e zero capital). Any smallish reduction is asset value wipes them out.

How could this happen? Even five years after the subprime crash, banks are essentially as exposed. The reason is simple: Basel Committee rules. Banks seem extremely well capitalized according to those rules, but in truthness they are anything but. The regulatory ratios are saying “job well done, you are now robust!”. The real ratios say “you are five minutes from death”.

American banks hate all this, because the rules force them into higher real capital ratios (though still not mountainously high). American banks envy their European sibblings.

But I bet that European taxpayers and depositors are the ones envying their US counterparts.

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