A 7% Tier one capital ratio for banks is the magic number we get from Basel. So what exactly will a 7 % T1 ratio achieve ? will it reform banking ? Does it deal with the reason behind the financial crises? Will it bring about a cultural change to the way Banks do business?The answer to all those important questions is a resounding NO. It just makes life a bit inconvenient for some banks in Europe, especially the German banks who negotiated down the rate. This is why we find that Deutsche Bank looking to raise capital. its stock fell 3.8% when news broke. So how do UK banks fair? Well they don't have to worry too much, because at the current rate the banks already have a T1 ratio of 10%! this might make you lead to a misleading conclusion that banks are doing well in the UK. That is too simplistic a view for a number of reasons which are beyond this blog, but suffice it to say that MER who lost 8 Billion from CDOs in the financial crises and made a loss of 2.3 billion has a T1 ratio of close to 8%. In the USA Goldman is expected to top the list with a T1 close to 11%. (apart from the fact that banks didn't have to report T1 ratios to the SEC until recently.)
So far Basel have moved 1% point upwards from a historical requirement of 6% to be classified as "Well capitalized" . Not to mention Calculating T1 ratios is not as straight forward as a P/E ratio. This depends largely due to banks being allowed to use "instruments" towards their capital ratio calculations. Ie its not just retained earnings, equity or FCF. In the end nothing has changed but a whole lot of noise has been successfully generated.
2 comments:
I really like the title and you have done some good research! Interesting read.
I recently took a training course in Financial Markets, run by a consulting firm, and I would like to point out what they what they told us about Basel III.
Basically, under Basel II banks were allowed to get away with very little 'real' equity. This could be as little as 2% if you stretched the rules to the limit. For example, a few percent could be borrowed money! Some hybrid instruments were also classified as core equity. This is what RBS took advantage of, apart from the losses because of ABN-AMRO.
However, now far fewer items can be categorised as 'core', thus making it harder for banks to get away. This is why DB has raised more equity. In some cases, some banks will have to triple their core ratios since about 6% has to be solid assets.
One can hope that what they told me is more or less correct. Furthermore, regarding your point about MER. Personally, I feel that capital ratios won't do much if the institution lending the cash isn't responsible for any default, etc. The 'originate-to-distribute' loans which were made to people who could never repay them, just for the purpose of short-term gains, have to stop! Can't play passing the risk ;)
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