Monday, 3 November 2008

UK banks tier one capital squeezed

There is nothing like a few bad investments to squeeze those tier one bank capital ratios.

Crudely speaking, bank capital is the difference between assets and liabilities. Banks need capital to absorb any losses on their assets (which are basically loans) in order to cover their liabilities (which are deposits).

Tier 1 capital is high quality capital - consisting of shareholders' equity, preferred stock and retained earnings. It is the key capital ratio targeted by regulators.

In a properly regulated banking system, banks are required to keep sufficient capital in order to meet all losses, even when the economy slides into recession. The depressing reality of the UK banking system is that tier one capital was declining during the good times, particularly after 2000. The FSA, with their notorious light touch, allowed banks to expand without supplementing this growth with additional capital.

There is another depressing observation; since the credit crisis began, the weakest banks in the system have become a lot weaker, with ratios declining well beyond what is safe and prudent. From a regulatory perspective, many UK banks are insolvent.

However, we didn't need a chart to tell us that; the UK financial system's overexposure to the crashing housing market told us that months ago.

4 comments:

Vado said...

Hence the government capital injection....

Nick Drew said...

not sure even "properly regulated banking systems" require banks to keep sufficient capital in order to meet "all losses"

just a high percentage (95% ? maybe 99% ?)

because 100% is unattainable and every extra '9' costs disproportionately more and more (like physical safety measures)

stakeholders must themselves diversify their holdings / exposures, in order to obtain the best possible protection, efficiently

doesn't exonerate Brown / FSA / BoE, of course, because manifestly they weren't requiring even this level of cover, or indeed adequate identification + measurement of the risks involved

it's not rocket science (well, some of it isn't)

Alice Cook said...

Nick

I am afraid banks must keep sufficient capital to cover all their losses. Otherwise, they would go bankrupt and that can't be allowed to happen.

Alice

Nick Drew said...

well yes, all their losses - until the final straw ...

leverage is leverage

even 6 nines is only 6 nines