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Most indebted banks are the European Central Bank and the Fed
By Ignacio de la Torre |
February 1, 2011, Tuesday
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Print Edition
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IMAGINE you have a shop that sells oranges. Your only asset is 10,000 euros' (US$13,707) worth of oranges, and you have a liability of 10,000 euros that you put into the business at the start from your own pocket.
One day you ponder the idea of asking the bank for a loan of 5,000 euros to fund 50 percent of the business so that you would have 5,000 euros to spend on doing something new in the shop. The idea doesn't last long.
That is an awful lot of debt for a fruit shop, and the bank manager would look at you as if you were out of your mind if you put it to him.
Yet the same bank that would refuse to give you your loan is operating with 500 euros of shareholder's money, and 9,500 euros comprised of "loans," ie, the money in our accounts, if we assume that the bank in question does not issue bonds in markets.
Obviously if our fruit seller friend were to ask for a loan of 9,500 euros to fund his 10,000 euros' worth of oranges, we would all agree that he had effectively gone mad, as would the bank manager, who probably has no idea that the bank where he earns his living operates with exactly the same level of debt.
And it is precisely that amazingly high level of financial gearing that has been the genesis of the credit crunch. In 1900, banks were funded using a third comprised of their own capital and two thirds of external funding (customer deposits).
Today, that ratio is no longer 1:2, but now tends to range between 1:19 and 1:40.
Capital flight
Basil III is aimed precisely at putting a stop to this type of dangerous funding structure, but in practice it is not that easy. If it stipulates that banks provide far greater amounts of their own funds, there will be significantly fewer returns for the shareholder, and there will be a swift flight of capital from the banking sector.
This would leave far less money available for loans, which in turn will put even more pressure on our embattled economy.
Nevertheless, there would appear to be consensus among regulators that the maximum gearing ratio permitted should be 1:33 (many European banks are currently operating with even higher gearing structures). Whatever the case, it is hardly a marked improvement over the present situation. So why am I telling you all this?
The bank with the highest level of gearing in the world is the European Central Bank. It currently holds 10,760 million euros, of which only half is disbursed at present, given that the incredible increase that almost doubled the previous amount has only recently been approved.
If you consider that the ECB's balance of payments currently stands at 2.04 billion euros, that means that the gear ratio of Europe's main bank now stands at over 1:186, and that prior to the recent increase it was - 1:345!
What perplexes me most is the fact that, in practice at least, the ECB serves as the ultimate guarantee for the stability of the European finance and banks. Does it make sense that this key guarantor is precisely the bank with the largest debt in the entire Eurozone?
Although arguments can be found to defend any position (we suppose that the ECB's assets are of better quality than those of most banks, and that its main liability are our bank notes, which are not callable), it would seem more hygienic to equip central banks with capital structures that serve as examples to follow by the banking system as a whole.
Tragicomic farce
If not, we will be as guilty of hypocrisy as politicians who force companies to adopt international accounting norms that include information on debt that does not appear on the balance sheet - while no government or state is obliged to provide information about their off-balance items (pensions), and no political party produces consolidated accounts that are anything more than a tragicomic farce.
In short, the issuer of the bank notes in our pockets is indebted by a multiple of 186. I'll leave you to reach your own conclusions on what kind of confidence such a balance inspires.
And guess which is the most indebted bank in the US, with a ratio of no less than 1:64.
Here's a clue. It begins with Federal and ends with Reserve.
Happy new year, all.
(The author is director of master's in finance of IE Business School of Spain. Shanghai Daily condensed the article.)
One day you ponder the idea of asking the bank for a loan of 5,000 euros to fund 50 percent of the business so that you would have 5,000 euros to spend on doing something new in the shop. The idea doesn't last long.
That is an awful lot of debt for a fruit shop, and the bank manager would look at you as if you were out of your mind if you put it to him.
Yet the same bank that would refuse to give you your loan is operating with 500 euros of shareholder's money, and 9,500 euros comprised of "loans," ie, the money in our accounts, if we assume that the bank in question does not issue bonds in markets.
Obviously if our fruit seller friend were to ask for a loan of 9,500 euros to fund his 10,000 euros' worth of oranges, we would all agree that he had effectively gone mad, as would the bank manager, who probably has no idea that the bank where he earns his living operates with exactly the same level of debt.
And it is precisely that amazingly high level of financial gearing that has been the genesis of the credit crunch. In 1900, banks were funded using a third comprised of their own capital and two thirds of external funding (customer deposits).
Today, that ratio is no longer 1:2, but now tends to range between 1:19 and 1:40.
Capital flight
Basil III is aimed precisely at putting a stop to this type of dangerous funding structure, but in practice it is not that easy. If it stipulates that banks provide far greater amounts of their own funds, there will be significantly fewer returns for the shareholder, and there will be a swift flight of capital from the banking sector.
This would leave far less money available for loans, which in turn will put even more pressure on our embattled economy.
Nevertheless, there would appear to be consensus among regulators that the maximum gearing ratio permitted should be 1:33 (many European banks are currently operating with even higher gearing structures). Whatever the case, it is hardly a marked improvement over the present situation. So why am I telling you all this?
The bank with the highest level of gearing in the world is the European Central Bank. It currently holds 10,760 million euros, of which only half is disbursed at present, given that the incredible increase that almost doubled the previous amount has only recently been approved.
If you consider that the ECB's balance of payments currently stands at 2.04 billion euros, that means that the gear ratio of Europe's main bank now stands at over 1:186, and that prior to the recent increase it was - 1:345!
What perplexes me most is the fact that, in practice at least, the ECB serves as the ultimate guarantee for the stability of the European finance and banks. Does it make sense that this key guarantor is precisely the bank with the largest debt in the entire Eurozone?
Although arguments can be found to defend any position (we suppose that the ECB's assets are of better quality than those of most banks, and that its main liability are our bank notes, which are not callable), it would seem more hygienic to equip central banks with capital structures that serve as examples to follow by the banking system as a whole.
Tragicomic farce
If not, we will be as guilty of hypocrisy as politicians who force companies to adopt international accounting norms that include information on debt that does not appear on the balance sheet - while no government or state is obliged to provide information about their off-balance items (pensions), and no political party produces consolidated accounts that are anything more than a tragicomic farce.
In short, the issuer of the bank notes in our pockets is indebted by a multiple of 186. I'll leave you to reach your own conclusions on what kind of confidence such a balance inspires.
And guess which is the most indebted bank in the US, with a ratio of no less than 1:64.
Here's a clue. It begins with Federal and ends with Reserve.
Happy new year, all.
(The author is director of master's in finance of IE Business School of Spain. Shanghai Daily condensed the article.)
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