4 thoughts on “To make banks strong, do away with the regulator”

  1. Posted 14/05/2020 at 10:24 | Permalink

    This is nonsense.
    Capital is an accounting concept, broadly the excess of a company’s assets over liabilities. This is a stable number. Market capitalisation is driven by a company’s share price, and hence expectations of future profits. This is a volatile number.
    UK and European banks have had low price to book ratios over the last 10 years because investors (rightly) consider that ultra low interest rates crimp bank’s profits.
    Banks have lots of capital and liquidity, so they are safe, but their returns are lower than their cost of capital, so their share prices (and hence market capitalisations) are low.
    Whether banks have ENOUGH capital to cope with the coming wave of bad debts is another matter. I suspect they do, but it might be tight.

  2. Posted 14/05/2020 at 23:24 | Permalink

    “This is nonsense.”
    Pray clarify what the nonsense is.

    “Capital is an accounting concept, broadly the excess of a company’s assets over liabilities. This is a stable number. Market capitalisation is driven by a company’s share price, and hence expectations of future profits. This is a volatile number.”
    Market cap is a perfectly valid measure of capital – I would say it is the best capital measure – and Dean Buckner’s and my report (which my blog posting links to) explains why in considerable detail.
    Merely asserting that X is a stable number and Y is a volatile one doesn’t get you very far.

    “UK and European banks have had low price to book ratios over the last 10 years because investors (rightly) consider that ultra low interest rates crimp bank’s profits.”
    Our report has an extensive discussion of the possible interpretations of low PtB ratios including a debunking of the argument you are making.
    This said, I am sure that ultra low interest rates are an important factor underlying low PtB ratios.
    The main issue with low PtB ratios however is simply this: low PtBs, whatever their interpretation, signal that something is wrong with the banking system. You seem to imply as much in your next paragraph, where you observe that banks’ returns are lower than their cost of capital.

    “Banks have lots of capital …”
    Your evidence being what, exactly? The high CET1 ratios highlighted by the BoE, perhaps? Or book values, or CET1?
    Here is mine: as of May 1, the big 5 banks had a market cap = 148.5 bn. Their total assets at end 2019 were £5,445.6 bn with an implied leverage of 36.7. That is a very low amount of capital in context and an awful lot of leverage.
    You might say use, e.g., book value shareholder equity instead. If we do that, then given the 42.7% average PtB, the book value becomes 148.5/0.427 = £348 bn, which is a lot more but still leaves the banks’ very highly leveraged. But to repeat, book value is not the best measure to use.

    “Whether banks have ENOUGH capital to cope with the coming wave of bad debts is another matter. I suspect they do, but it might be tight.”
    Banks don’t HAVE capital, they ISSUE it. To say that banks ‘have’ capital is to suggest that a bank’s capital is an asset to it. This is incorrect. A bank’s capital is a form of liability to the bank that issues it. Placing bank capital on the wrong side of the balance sheet is an elementary error, also discussed in our report. You are far from being the only one to make this error, however.
    If banks market cap is £148.5 bn, then losses > that number wipe out the (market) capital of the banks. I am sure the banks’ losses will exceed £150 billion. “Tight” is not quite the word I would use.

    Thanks for your comments.

  3. Posted 15/05/2020 at 10:58 | Permalink

    “Capital is an accounting concept, broadly the excess of a company’s assets over liabilities. This is a stable number. ”

    But capital is a liability (to the shareholders of a company). So the excess of assets over liabilities is zero?

  4. Posted 18/05/2020 at 13:24 | Permalink

    “…raise minimum required capital to, say, 20% of market capitalisation to total assets; enforce that minimum by banning dividends, bonuses and buybacks until that minimum is met…”

    Kevin, is this not a form of regulation?

    And where was the 20% figure plucked from? Might it not be better for investors to assess for themselves whether they think that the bank is holding enough capital? An appropriate level must surely depend on the type of lending in which the bank is engaged, so why should it be a standard across the industry? Do we not want investors to exercise their own judgement rather than trusting to regulation?

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