Iceland is the standout performer for 2012

Iceland does it their way.

Emotionally, I love Iceland’s financial policies since the crash of 2008:

Iceland went after the people who caused the crisis — the bankers who created and sold the junk products — and tried to shield the general population.

But what Iceland did is not just emotionally satisfying. Iceland is recovering, while the rest of the Western world — which bailed out the bankers and left the general population to pay for the bankers’ excess — is not.

Bloomberg reports:

“Few countries blew up more spectacularly than Iceland in the 2008 financial crisis. The local stock market plunged 90 percent; unemployment rose ninefold; inflation shot to more than 18 percent; the country’s biggest banks all failed.

This was no post-Lehman Brothers recession: It was a depression.

Since then, Iceland has turned in a pretty impressive performance. It has repaid International Monetary Fund rescue loans ahead of schedule. Growth this year will be about 2.5 percent, better than most developed economies. Unemployment has fallen by half. In February, Fitch Ratings restored the country’s investment-grade status, approvingly citing its “unorthodox crisis policy response.”

So what exactly did Iceland do?

First, they create an aid package for homeowners:

To homeowners with negative equity, the country offered write-offs that would wipe out debt above 110 percent of the property value. The government also provided means-tested subsidies to reduce mortgage-interest expenses: Those with lower earnings, less home equity and children were granted the most generous support.

Then, they redenominated foreign currency debt into devalued krone, effectively giving creditors a big haircut:

In June 2010, the nation’s Supreme Court gave debtors another break: Bank loans that were indexed to foreign currencies were declared illegal. Because the Icelandic Krona plunged 80 percent during the crisis, the cost of repaying foreign debt more than doubled. The ruling let consumers repay the banks as if the loans were in Krona.

These policies helped consumers erase debt equal to 13 percent of Iceland’s $14 billion economy. Now, consumers have money to spend on other things. It is no accident that the IMF, which granted Iceland loans without imposing its usual austerity strictures, says the recovery is driven by domestic demand.

What this meant is that unsustainable junk was liquidated. While I am no fan of nationalised banks and believe that eventually they should be sold off, there were no quick and easy bailouts that allowed the financial sector to continue with the same unsustainable bubble-based folly they practiced before the crisis (as has happened throughout the rest of the Western world).  

And best of all, Iceland prosecuted the people who caused the crisis, providing a real disincentive (as opposed to more bailouts and bonuses):

Iceland’s special prosecutor has said it may indict as many as 90 people, while more than 200, including the former chief executives at the three biggest banks, face criminal charges.

Larus Welding, the former CEO of Glitnir Bank hf, once Iceland’s second biggest, was indicted in December for granting illegal loans and is now waiting to stand trial. The former CEO of Landsbanki Islands hf, Sigurjon Arnason, has endured stints of solitary confinement as his criminal investigation continues.

That compares with the U.S., where no top bank executives have faced criminal prosecution for their roles in the subprime mortgage meltdown. The Securities and Exchange Commission said last year it had sanctioned 39 senior officers for conduct related to the housing market meltdown.

Iceland’s approach is very much akin to what I have been advocating — write down the unsustainable debt, liquidate the junk corporations and banks that failed, disincentivise the behaviour that caused the crisis, and provide help to the ordinary individuals in the real economy (as opposed to phoney “stimulus” cash to campaign donors and big finance).

And Iceland has snapped out of its depression. The rest of the West, where banks continue to behave exactly as they did prior to the crisis, not so much.

THE PROBLEM WHEN BANKS ARE TOO BIG TO FAIL

 This article was written by Alan Kohler one of my favorite commentators on the Australian and Global Financial Issues:

 A New York hedge fund manager told the ADC Leadership Retreat at Hayman Island on the weekend that he expects US bankers to be led away in “handcuffs and pajamas” pretty soon over Libor rigging. What’s more, he reckons, civil damages over the scandal could end up being greater than all bank capital.

Nobody believed him; the audience smiled politely and moved on, thinking: “yeah, sure”. The market’s not too worried either: Barclays’ shares are up 22 per cent from their post Libor lows, and back to where they were in May, and shares in Standard Chartered Bank, which has been fined $340 million for breaking US sanctions on Iran, have gone up 16 per cent since that scandal broke.

But leaving aside the (remote) possibility of arrests over Libor rigging and the slap on the wrist for Standard Charter over Iran, you’d have to say the world’s bankers have gotten away with the greatest two scams in history, which are the US Sub-prime Mortgage Affair and the Great Euro Periphery Heist. Not only have they not been arrested in their pajamas, they haven’t had to give back their bonuses, regulators are getting nowhere and governments are still baling them out with cash and cheap money.

The difference between their treatment and that of the tobacco companies is rather stark, you’d have to admit.

In Australia the banks didn’t join in the two big scams, at least not much anyway, because they’re better regulated and APRA wouldn’t let them. But they’re making hay now because their competitors have disappeared along with the swindle-ridden securitised mortgage market.

As a result, they have rebuilt their net interest margins and have become the world’s most profitable banks according to return on net assets. Of them, Commonwealth Bank is the stand-out: it’s the world’s most expensive bank by market value to net assets and yesterday broke $7 billion in profit (still only about a quarter of JP Morgan’s profit).

At this point after the 1929 crash, which was also caused by banks, US Congress had received the report of the Pecora Commission and already passed the Banking Act, also known as the Glass-Steagall Act, which separated the activities of banking and dealing in securities. In general, the regulatory attack and public opprobrium on banks in the 1930s was ferocious and effective.

The new law lasted for 66 years until it was repealed in 1999 as a result of bank lobbying. They were then free to do again what they did between 1922 and 1929, and the result was the same except this time politicians and central bankers are scared of them, not ferocious.

Not only has there been no Ferdinand Pecora, the fierce senior counsel to the US Senate Committee on Banking and Currency in 1932 whose name went on their report, but the efforts to re-regulate them have been pathetically easy to deal with (the banks have been playing whack-a-mole with politicians) and central bankers have been keeping the insolvent banks alive with cheap money. 

This time, you see, the banks are ‘too big to fail’. That means they are too big to prosecute as well, by the way, since prosecution usually means failure, and they’re too rich to regulate. That means bankers are above the law as well as fantastically rich and powerful.

There is one potential as the new Ferdinand Pecora: Gary Gensler, the chairman of the US Commodity Futures Trading Commission, who led the investigation into Barclays and the $450 million settlement with it, and is now conducting a global investigation into rate-rigging by more than a dozen banks, and is pushing hard for a return to Glass-Steagall.

But how come the CFTC, which regulates futures, is suddenly leading the charge against the banks and emerging as the banking regulator? Because there was a little provision in the 2,319 page Dodd Frank Act that was passed in 2010 to respond to the GFC, that the banks didn’t notice or didn’t realise the importance of, so they didn’t lobby to have removed. It greatly expanded the responsibility of the CFTC in regulating derivatives, and the 2008 banking crash, unlike the 1929 one, was all about derivatives. Every euphoria and panic has something new, and this time it was banking derivatives.

The thing the banks focused on in their lobbying was the Volcker Rule, the section of the Act that was meant to reintroduce a form of Glass-Steagall, specifically banning proprietary trading (“we must be able to gamble – it’s vital”).

So far the banks have managed to emasculate that rule, although the recent epiphany of Sanford Weill, the former Citibank CEO who was responsible for the repeal of Glass-Steagall, has swung opinion back towards strengthening it again. Weill mused in an interview that, actually, maybe it wasn’t a good idea to repeal Glass-Steagall after all and maybe banks shouldn’t be allowed to do anything they want. The latest convert is Paul Ryan, the Republican vice-presidential candidate for this year’s election.

But the underlying problem is that if they’re too big to fail, they’re too big to regulate, and the efforts to do something about that more fundamental problem are moving very slowly. In November last year, at their summit in Cannes – three years after the crash – G20 leaders asked the Basel Committee and the Financial Stability Board to look into it. They have come up with the idea of a capital surcharge for “globally systemically important banks” (G-SIBs) as well as “improving global recovery and resolution frameworks”, whatever that means.

The Basel Committee has just released a consultative document for dealing with “domestically systemically important banks” (D-SIBs) which is waffly and about as far from Ferdinand Pecora as is possible to be.

In fact, Australia’s APRA could teach them what to do, and it’s all about vigilance, not rules.

APRA has a wonderfully named system called PAIRS/SOARS, which stands for Probability and Impact Rating System (PAIRS) and the Supervisory Oversight and Response System (SOARS). Basically, and to cut out the jargon, APRA is all over them like a cheap suit, constantly issuing speeding tickets and forcing changed behaviour.

Unless you’re going to break the banks up so there’s lots of little ones instead of really big ones, that sort of principles-based, hands-on regulation is the only way to go.

It works in Australia but would it work in the United States? Perhaps not: money doesn’t talk there, it shouts.

Check out http://www.businessspectator.com.au for similar articles of quality and insight.

Is the American Government lying about the debt crisis?

Written by Martin D. Weiss, Ph.D. of “Money and Markets” eletter@e.moneyandmarkets.com

Do you believe what government officials and experts are saying about the debt crisis?

If so, you’re taking your financial life into your hands.

Just consider how many times they’ve been wrong,

issued deliberately misleading statements, or simply lied:

In 2007, they swore on a stack of Bibles that the debt crisis

was limited to sub-prime mortgages.

 

But the crisis promptly spread to all kinds of mortgages,

ripping through giant mortgage lenders like Countrywide,

Fannie Mae, and Freddie Mac.

In 2008, they admitted it had spread,

but swore that it was strictly contained to the housing and mortgage sector.

But in a few short months, it had enveloped commercial paper,

money markets, and nearly all of Wall Street.

Nearly every one ofAmerica’s largest banks either failed

or came within a hair of insolvency.

 

In late 2009, they rescued the bankrupt banks and mortgage lenders

using the $700 billion in emergency capital approved

under the Trouble Asset Relief Program (TARP).

Then, they ran deliberately lenient “stress tests”

on the biggest banks to “prove” to the public

that the emergency had passed.

 

But with the government now assuming liability for trillions of mortgages

and other bank obligations,

they transformed a Wall Street debt disaster

into an even largerWashingtondebt disaster:

The federal deficit ballooned to four times its pre-crisis size.

And in the euro zone,

where governments had also pumped massive sums into bankrupt banks,

the weakest countries likeGreecebegan to collapse.

In 2010, the European Union and the International Monetary Fund

put together a sovereign debt rescue package

that was even larger than TARP.

They pulledGreecefrom the precipice and

vowed never to let the contagion reel out of control.

 

But within a few short months,

the contagion toppledIrelandandPortugal

threatened a similar fate forSpain,Italy, andBelgium,

and even raised serious questions about the financial fate

of the two largest economies in the euro zone -FranceandGermany.

 

Clearly, each outbreak of the contagion, each government rescue,

and each new happy-talk pronouncement

has merely spawned a bigger disaster, impacting bigger institutions.

Has gutted the portfolios of more investors,

and ruining the lives of millions more Americans.

Now, here we are halfway into 2011 and they’re at it again.

This time with a complete package of misleading statements

and lies that make all previous ones seem candid by comparison.

 

Lie #1. They’re again saying that the debt crisis of 2008-09 is “history.”

 

The truth: The core cause of the crisis —

the gigantic pyramid of high-risk derivatives —

has never gone away.

 

Quite the contrary, the pile-up of derivatives on the books

of majorU.S.banks is now much larger — $244 trillion,

compared to less than $200 trillion before the debt crisis,

according to the U.S. Comptroller of the Currency (OCC).

 

Lie #2. They say thatAmerica’s largest banks have virtually no exposure

to a Greek debt default or a broader European sovereign debt crisis.

 

The truth: All major European andU.S. banks are linked through an even larger global network of derivatives,

now representing more than $600 trillion,

according to the Bank of International Settlements.

 

Therefore, even thoughU.S.banks may not hold large amounts

of European debts themselves,

they are directly exposed to European banks

that do hold large amounts of loans to

Greece,Ireland,Portugal, and others in jeopardy.

 

 

Lie #3. They insist thatAmerica’s largest banks are safe.

 

The truth: The largestU.S. banks continue to hold

nearly all of the derivatives in the country.

Goldman Sachs has $44.9 trillion in derivatives.

Bank of America has $52.5 trillion.

Citibank has $54.1 trillion.

And JPMorgan Chase towers over all others with $79.5 trillion

of these potentially dangerous investments.

 

In total, JPMorgan, Goldman, Citibank, and the BofA alone are exposed to $234.7 trillion in derivatives.

In contrast, among the thousands of other U.S.banks, the grand total of derivatives is a meagre $9.3 trillion.

In other words, these four banks are exposed to more than 25 times

the sum total of all derivatives held by every other bank in theUnited States.

Never before has so much financial power — and risk — been concentrated in the hands of so few!

Yes, these numbers, reflecting the “notional” value

of the financial instruments at play,

are far larger than the actual amounts invested.

But still, the risks are huge …

The derivatives held by Bank of America are

36 times larger than TOTAL assets;

 

At JPMorgan Chase, they’re 46.1 times larger than the assets;

 

At Citibank, 46.6 times larger; and

 

At Goldman Sachs Bank, a shocking 533 times larger!

Yes, in recent months,

some banks have reduced somewhat their exposure to defaults

by their counterparties.

But here again, the exposure remains massive:

According to the OCC, for each dollar of capital …

Bank of America has $1.82 in credit exposure to derivatives;

 

Citibank also has $1.82;

 

JPMorgan Chase has $2.75; and

 

Goldman Sachs is, again, at the greatest risk of all —

with $7.81 in credit exposure for each dollar of capital.

 

That means that if JPMorgan’s counterparties defaulted on 36% of their derivatives, every last dime of the company’s capital would be wiped out.

And at Goldman Sachs,

defaults on just 13% of its derivatives would wipe out its capital.

 

Lie #4. Misinformation about the government’s supersized debts is equally egregious.

They want you to believe that, although large,

the government’s debts are far below the danger zone —

thought to be around 100% ofGDP.

 

The truth: According to the Fed’s latest Flow of Funds report, the U.S. Treasury owes a total of $9.6 trillion, 64% ofGDP, which isn’t too bad.

But the U.S.government is also responsible for $7.6 trillion in debts

owed by government agencies, such as Fannie Mae and Freddie Mac.

The U.S.government’s total debt burden: $17.2 trillion

or 115% of GDP—

similar or WORSE than that of countries like

Greece, Ireland, Portugal, and Spain!

 

Lie #5. They argue thatAmerica is special because it controls the world’s dominant reserve currency.

The truth: Yes, that givesWashington the ability to print money with impunity … press other rich countries to accept its debts,

and borrow huge amounts abroad to finance its deficits.

But it’s more of a curse than a blessing!

 

It means that, more so than any other major nation,

theU.S.government is beholden to investors overseas —

often the same investors who have repeatedly attacked countries

like Greece and Ireland.

Ultimately, that could make the  U.S.even more vulnerable than Europe.

 

Now the question is, what do you think?

The debate is Australia is often confused by Slogans that Politicians pump out, to gloss over the truth,

and to make you to think everything is not OK,

except if things where handled their way they would fix it.

And the problem would go away. That is far too simple.

The truth of the matter is far more complex than that.

And while facts presented here are correct,

does it actually mean the USA economy is at risk?

Well to clarify the issues you really need to understand how “Hedge” markets operate, and what is the size of the overall world market? And which other institutions share the risk? Or how they mitigate it?

 

The role of the Hedge market is actually to mitigate risk, not create risk.

Certainly there are speculators playing in the market, and spikes in the market soon show if interest in a particular area is out of proportion with the rest of the market. To rely on regulators and Government authorities to manage or monitor excesses in this market is extremely difficult. You need to assess this whole complex area with a clear mind, and measure the potentiality of any risk that could cause this market area to implode.

Complex yes but not outside a reasoned explanation that would reduce the level of anxiety that the tenor of this article creates.

 Tell me what you think? 

Standard and Poor Updates its Assessment of Basil III’s Impact on the World Banks’ Strength.

Despite Significant Progress, Capital Is Still A Rating Weakness For Large Global Banks

 Following a review, Standard & Poor’s Ratings Services considers that the risk-adjusted capital (RAC) positions of large banks in mature markets around the globe are generally a rating weakness. Our opinion is consistent with the results of studies published last month by the Basel Committee and the Committee of European Banking Supervisors, which concluded that there is a significant capital shortfall under the Basel III computation rules for global banks compared with the final Basel III minimum requirements. Specifically, some of the 75 large banks included in the studies would need an additional €577 billion ($763 billion at the current USA exchange rate) to meet the final 7% minimum common Tier 1 ratio (see “Basel’s Global Quantitative Impact Study Exposes Large Banks’ Regulatory Capital Shortfall,” published on RatingsDirect on Dec. 20, 2010).

Several key aspects of the Basel III reform package are yet to be determined, however, including the potential capital surcharge for systemic banks. In addition, some technical details of Basel III that are likely to have a material impact on regulatory ratios remain unknown (such as the final details of the Credit Valuation Adjustment charge). We believe that these factors, as well as the lengthy transitional arrangements, including the grandfathering by regulators of certain hybrid debts until 2023, may continue to blur comparability and consistency over time of banks’ Tier 1 ratios.

In this context, and given the observed limitation for global comparisons of regulatory capital ratios, we base our opinion of banks’ capital adequacy on our criteria for our risk-adjusted capital framework (RACF) because we believe it provides a globally consistent metric of financial institutions’ capital and risks. It also reflects our opinions on credit, market, and operational risks (see “Bank Capital Methodology And Assumptions,” published Dec. 6, 2010).

This report provides an update to “S&P Ratio Highlights Disparate Capital Strength Among The World’s Biggest Banks,” published Nov. 30, 2009, in which we compared banks’ risk-adjusted capital adequacy with regulatory Tier 1 ratios using a global sample of 45 large banks. In our latest report, we have extended our sample size to include 75 of the top 100 banks by asset size. The RAC ratios presented in this report reflect the changes made in our computation methodology in our December 2010 RACF criteria update, which had a material impact on some banks’ RAC ratio levels.

Key Findings Of Our Analysis

We note that:

• Significant disparities in capital strength persist among the large banks despite high regulatory ratios. The relative differences of our calculation of risk-adjusted capital (RAC) ratios do not match those of regulatory Tier 1 ratios. In our view this reflects both discrepancies in the computation of Tier 1 ratios as well as our different approach to risk assessment and defining capital compared with national regulators;
• Capital adequacy has been improving steadily for most banks in our sample, but in our view it remains a relative weakness for the majority of large banks around the globe. Despite most banks averaging double-digit Tier 1 ratios, a minority of banks in our sample achieved RAC ratios before and after diversification of more than 8% at mid-year 2010. Under our RACF methodology, we consider that a RAC ratio of 8% indicates that a bank should have sufficient capital to withstand an ‘A’ or substantial stress scenario in developed markets.
• The correlation between existing RAC ratio levels and banks’ counterparty credit ratings is only moderate, however. While we consider a bank’s capital position to be an important rating factor, we consider factors such as sovereign support, business position, risk-adjusted earning levels, and funding profiles to be important as well;
• Of the 75 banks in our sample, banks in Australia, Singapore, Hong Kong, and the Nordic countries had the highest average RAC ratios; banks in Japan and Austria had the lowest;
• The rankings for some banks changed substantially between June 2009 (as published in our November 2009 survey) and June 2010, which in our view highlights differences in the speed and aggressiveness of de-risking and recapitalization policies. Several of the banks with the lowest RAC ratios at June 2009 managed to catch up, at least partially, with the average ratio of the banks in the sample;

When we assess a bank’s capital adequacy, we complement the RAC ratio with a qualitative analysis of that bank’s capital position. This includes looking at the quality of capital (for example, the amount of hybrids versus core equity), the quality of underwriting (compared with banks within the same market), and the bank’s capital-generation ability and financial flexibility (that is, the capacity of a bank to raise equity in times of crisis). We also look at other forms of loss-absorbing securities that may have been issued by the bank and that may not be part of our measure of capital (such as the full amount of government hybrids in some instances);

We expect some convergence over time between Basel III ratios and our RAC ratios, as our RAC framework already anticipates several aspects of Basel III;

The implementation of Basel III is unlikely to remove all consistency issues in regulatory Tier 1 ratios. We expect some divergence to persist owing to the impact of national discretion, the expected long transition period, as well as differences in banks’ internal model calibrations, which could continue to generate competitive distortions and weigh on market discipline.

Capital Is Still A Negative Rating Factor For The Majority Of Large Banks, Despite Some Improvement

In our view, most banks’ RAC positions demonstrated steady improvement in 2010. The banks in our sample appear to have started to prepare for a future structural increase in regulatory capital requirements under Basel III. Capital raising, conversion of hybrids into common equity, suspension of dividends, asset disposals, and a reduction in risk assets have allowed a number of banks to significantly increase their capital ratios in the past 18 months.

Having reached a low point in 2007, the average Tier 1 ratio of banks in our sample had increased by about 300 basis points (bps) as of June 30, 2010, with acceleration since year-end 2008.

As of June 30, 2010, our average estimated RAC ratio for the 75 banks in our sample was 7.0% before diversification/concentration adjustment and 8.0% after, compared with an average of 5.7% and 6.7%, respectively, at June 30, 2009. This 130 basis point (bp) rise primarily reflects an increase in banks’ risk-adjusted capital positions. About 40 bps of this reflects the application of our revised RACF criteria published in December 2010–see “Bank Capital Methodology And Assumptions”. Beyond this 40 bp criteria-related average improvement in RAC, significant disparities must be noted with some banks’ RAC ratios that have experienced a significant negative impact related to the deduction of tax loss carried forward and others that report a gain that is higher than 40 bps. The increase in sample size from 45 to 75 banks has had no material impact on the average RAC ratio. We consider that this average level remains a relative rating weakness for banks, which are mostly in the ‘A’ and ‘AA’ categories.

A minority of banks in our sample achieved a RAC ratio of 8% both before and after the impact of diversification/concentration adjustment. Under our RACF, we consider that a RAC ratio of 8% indicates that a bank should have sufficient capital to withstand an ‘A’ or substantial stress scenario in developed markets. However, we expect some further improvement in RAC ratio levels. Under our proposed new bank criteria, we intend to apply RAC ratio ranges to projected RAC ratios rather than current RAC ratios (see “Criteria | Financial Institutions | Request for Comment: Banks: Rating Methodology,” published Jan. 6, 2011).

Our estimated RAC ratios include a numerator that is computed as of June 30, 2010. However, owing to a lack of comprehensive Pillar 3 disclosure at that time, the denominators of the estimated RAC ratios at June 30, 2010 for non-U.S. banks are mainly based on our estimated risk-weighted assets (RWAs) at June 30, 2010 (with a few exceptions). We assessed the variation in regulatory RWAs between the date of calculation with comprehensive Pillar 3 disclosure and June 30, 2010 and applied the same variation to our RWAs. In the absence of timely global disclosure, we believe that this methodology, despite its imperfections, should provide a good estimate of the June 30, 2010 RAC ratios. For U.S. banks we used different data sources. Detailed assumptions used in the case of U.S. banks are available in Appendix 2. We believe that the different information sources and assumptions used to compute RAC ratios could translate into marginal discrepancies in ratio levels.

The RAC ratios published in this article reflect our existing criteria at the time of publication (please see Related Research And Criteria section below for a list of our criteria, as well as our Request For Comment articles on hybrids and BICRA methodology).

Table 1 shows the major differences in our calculation of banks’ RAC ratios both before and after diversification. Capital is one of the main factors driving the below-average ratings of the banks with the lowest RAC ratios in our sample. Conversely, banks with the highest RAC ratios both before and after diversification on average have the highest ratings in this sample.

We view the correlation between RAC ratios and ratings as moderate, however. The RAC is just the starting point for our capital analysis, which we complement with a qualitative analysis of other measures and instruments. We also take into account numerous other rating factors that are not related to banks’ capital positions.

Qualitative analysis of banks’ capital positions complements RAC ratio for a more balanced picture

When we assess a bank’s capital adequacy, we complement the RAC ratio with a qualitative analysis of that bank’s capital position. For example, in the case of Credit Suisse we assess that the bank’s RAC ratio would be more than 200 bps higher without the deduction of tax loss carried forward. In our analysis of Credit Suisse’s capital position, we factor in our view that the bank would recover a large part of those taxes in the next few years and, as a result, would likely demonstrate a higher ability than its peers to build capital in the near future.

The impact of our decision to systematically deduct tax losses carried forward from our total adjusted capital (TAC) measure (published in our RACF criteria in December 2010) has been negligible for the ratios of the majority of banks in our sample for which tax loss carried forward was already deducted or was not material. It has been more material, however, for a minority, which includes UBS, Credit Suisse, Lloyds Banking Group PLC, Societe Generale, Canadian Imperial Bank of Commerce, Banco Santander S.A., Deutsche Bank AG, Bank of Nova Scotia, Commerzbank AG, KBC Group N.V., BPCE, Royal Bank of Scotland Group PLC, and BNP Paribas.

Our analysis of banks’ RAC positions also leads us to make qualitative adjustments to our RAC ratios to reflect differing underwriting standards within the same market, as well as variation in banks’ capital-generation capacity and financial flexibility. For example, when we compare the RAC computation of Caja de Ahorros y Monte de Piedad de Madrid (Caja Madrid) or Banco Popular Espanol, S.A. (Popular) with that of Banco Bilbao Vizcaya Argentaria, S.A. (BBVA) and Caja de Ahorros y Pensiones de Barcelona (la Caixa) we take into consideration our view of the latter two banks’ lower risk appetite, more conservative underwriting standards, and stronger financial flexibility than the first two.

The low RAC ratios for KBC Bank N.V., Danske Bank A/S, and Commerzbank at June 30, 2010 do not include the full amount of hybrid capital instruments injected by their respective governments (for example, out of the €16.4 billion of hybrids provided by the German government in the case of Commerzbank, only €3 billion are included in the TAC). We consider, however, that these hybrids support the banks’ capital positions, at least in the medium term.

We believe that some actions taken by banks after June 30, 2010 have already had a significant impact on their respective RAC ratios. On a pro forma basis, we estimate that Deutsche Bank’s RAC ratio gained 100 bps following the €10.2 billion rights issue in October 2010 and the acquisition of the majority of Deutsche Postbank AG’s capital. Standard Chartered Bank also injected $5.2 billion of pure equity by way of a rights issue in fourth-quarter 2010. According to our estimates, the bank’s pro forma RAC ratio after diversification as of June 2010 would reach 11.4% (up from 9.5%). In addition, we estimate that the impact of BBVA’s €5.1 billion rights issue completed in November 2010 would increase our estimated RAC ratio at mid-2010 by 111 bps before diversification and 130 bps after. Under our methodology, however, we note that this capital increase is projected to be almost entirely consumed by the expected €4.2 billion acquisition of a stake in Turkiye Garanti Bankasi A.S. (expected to close in the second quarter of 2011) and BBVA’s contribution to the CITIC Group’s planned capital increase in 2011. Our RAC ratio for Popular is likely to increase from our 8.9% estimate at June 30, 2010 as a result of the impact of the €500 million issuance of mandatory convertible bonds, the €179 million share capital increase to allow Credit Mutuel to enter in Popular’s capital, and the decreasing impact on RWAs of the transfer of assets to the joint venture created with Credit Mutuel. We estimate the combined impact of these developments to be in the range of 60-80 bps.

Finally, the three Chinese banks included in our sample (China Construction Bank, Bank of China Ltd., and Industrial and Commercial Bank of China) made significant capital injections since June 30, 2010, which, we estimate, would increase their RAC ratios by more than 50 bps.

In addition to these significant capital raisings, a number of other banks in our study have undertaken capital-raising exercises since June 30, 2010 that generally would have the potential to raise their RAC ratios by less than 50 bps. Furthermore, this does not take into account other post-June 30, 2010 items, including changes to RWAs, earnings, or losses, and dividends and other items that may also impact the RAC calculation. We note, for example, that our RAC ratio estimates as of June 30, 2010 for la Caixa reflect a relatively low point over the last year (see table 4), and that its RAC ratio is likely to increase over the following few quarters by about 50 bps.

Our bank ratings also reflect additional factors that are not related to capital:

• More than one third of the banks in this sample benefit from explicit government support, for example, Citigroup, KBC, and Mizuho. We anticipate that the capital position of many of these banks will improve significantly by the time government support is removed.
• Funding position is also an important factor: We view Dexia’s unbalanced structural funding position as a key factor contributing to its lower-than-average rating; this is only partially mitigated by its better-than-average RAC ratio.
• We consider that some banks in the ‘AA’ rating range, for example BNP Paribas, BBVA, or Wells Fargo, and ‘AAA’ rated Rabobank, have RAC ratio levels that are not a rating strength for the very high ratings. However, in our view this is balanced out by the strength of their business franchise, their strong management track record, and better risk-adjusted earnings performance than peers’ that they demonstrated throughout the crisis.
• The ratings on the large Chinese banks included in this sample are lower than average despite them achieving average RAC ratios, which could be even higher when we take into account their sizable rights issues completed in the fourth quarter of 2010. Their ‘BBB’ category stand-alone credit profiles primarily reflect our view of the higher-than-average risks associated with the operating environment in China.

New Reforms Could Narrow The Gap Between Our RAC Ratios And Regulatory Tier 1 Ratios

Our current RAC ratios are not only significantly lower on average than Basel I and II Tier 1 ratios, but also outline significant differences in the relative capital strength among financial institutions (see table 1). This primarily reflects differences in opinion regarding definitions of capital and the riskiness of trading operations equity portfolios and securitization tranches. Our view of the magnitude of credit risk also explains the larger gaps with Tier 1 ratios that we observe in countries which we consider to be higher risk than those in countries of lower economic risk. Australian banks, whose Tier 1 ratios are computed more stringently than the international average, achieve both the lowest Tier 1 ratios and among the highest RAC ratios before diversification adjustments. In our view, these discrepancies between our calculations and those based on Basel requirements result from more stringent definitions of capital and a more conservative computation of risk weights for some asset classes (such as residential mortgages). This modest difference with RAC ratios in our sample of Australian banks is also the result of their limited trading operations and equity portfolios.

German commercial banks, Austrian banks, and Japanese banks in our sample clearly achieve weaker-than-average RAC ratios despite achieving Tier 1 ratios that are similar to the international average. We attribute this larger-than-average gap with Tier 1 ratios to a high proportion of hybrids in their Tier 1 capital and in some instances to large equity participation portfolios, or significant holdings of non-investment-grade securitization in the case of some German banks. Higher credit risk embedded in Austrian banks’ Central and Eastern European banking activities also places pressure on RAC ratio levels. Banks with large investment banking activities, equity, and private equity portfolios also have a large gap between Tier 1 and RAC ratio levels.

We attribute the significant gap between Chinese banks’ RAC ratios and their reported Basel 1 core capital adequacy ratios to the higher risk weights for their assets under our RACF, particularly for corporate loan portfolios and interbank exposures. This in turn reflects our view of moderately high credit risks embedded in the economy. The gap between our RAC ratios and reported Basel ratios also reflects the absence of operational risk charges in countries such as China or the U.S., where the Basel I framework is still being used. The magnitude of tax loss carried forward that is still recognized by local regulators is also a material driver of the differences in countries such as Switzerland, Germany, or France.

The expected implementation of the trading book reform (otherwise known as “Basel 2.5″) in January 2012 and the Basel III framework should, in our view, reduce the gap between RAC and regulatory ratios. Our RAC ratio appears much closer to future Basel III Tier 1 ratios than the existing double-digit Tier 1 ratios published around the globe. The average RAC ratio before diversification in our current sample of 75 banks was slightly below 7% at year-end 2009 and would have been below 6% if we had computed a common equity RAC, excluding all hybrids. In the Bank for International Settlements Quantitative Impact Study results disclosed last December, the average Tier 1 common ratio of 74 large banks–defined as internationally active banks with Tier 1 capital of more than €3 billion ($4 billion)–would have almost halved to 5.7% from 11.1%.

Basel III definition of regulatory capital could lead to a much cleaner regulatory capital base over time

The full implementation of Basel III, expected by 2023, should in our view significantly reduce the gap between regulators’ definition of Tier 1 capital and our own capital measure, total adjusted capital (TAC). We believe the disparities observed primarily reflect our stricter criteria and lower acceptance of hybrid capital in TAC compared with Tier 1 capital that regulators compute. We expect that the dominant part of Basel III regulatory Tier 1 capital will be composed of common equity and reserves and that recognized hybrid capital will have a higher loss-absorption capacity on a going-concern basis than today. Other material differences that are likely to disappear include the treatment of pension deficits, revaluation reserve, and tax loss carried forward that we systematically deduct from our definition of capital (see “Bank Capital Methodology And Assumptions,” published Dec. 6, 2010).

Table 2

Calculation Of Total Adjusted Capital

Common shareholders’ equity

Add minority interests: equity

Deduct dividends (not yet distributed)

Deduct revaluation reserves

Deduct goodwill and non-servicing intangibles

Deduct interest-only strips

Deduct deferred tax loss carry forwards

Add or deduct postretirement benefit adjustments

Add or deduct cumulative effect of credit-spread related revaluation of liabilities

Add or deduct other equity adjustments

= Adjusted Common Equity (ACE)

Add preferred stock and hybrid capital instruments (subject to limits)

= Total Adjusted Capital (TAC) 

We believe we will continue to see some differences between regulators’ definition of capital and our own capital measure, such as in the treatment of insurance subsidiaries and unconsolidated interests in financial institutions that we will risk weight at 1250%, equivalent to a one-for-one capital charge, whereas the Basel III standards require deducting them from Tier 1 above a certain ceiling.

Conversely, while Basel III will not allow full consolidation of minority interest in operating subsidiaries beyond local regulatory minimum requirements, we fully recognize this in our capital ratio. We may subsequently adjust qualitatively to factor in our view of potential capital fungibility limitations.

Upcoming Basel III capital requirements may result in fewer differences between RAC and regulatory ratio risk charges

The two main areas where we expect some convergence between the RAC risk weights and Basel risk weights are trading risk and securitization. Regarding the computation of RWAs, the implementation of the stress value-at-risk (VaR) and incremental risk charge planned for year-end 2011 (under the Basel 2.5 rules) will significantly reduce the gap with our existing RAC charge, which is currently 3-4x higher than the Basel VaR-based charge for the trading book.

Likewise, we believe that this gap will disappear with the proposed risk-weighting of securitization equity tranches at 1250% under Basel III–a treatment that we already apply in our current RAC framework.

The remaining material differences that we expect to see between our RAC risk weight and those under Basel III are, in particular, our higher risk weights for equity and private equity portfolios, for which we believe that existing regulatory charges are generally too low (Basel III will not modify the regulatory charge for equity portfolios, which range from 8%-32%, depending on the nature of the portfolio and the methodology used by the banks). We also expect our credit risk weights that set benchmark charges through the cycle at asset class and country levels to remain on average higher than those under Basel II’s internal rating-based approach, which are set using a stressed one-year horizon. Operational risk charge, which is primarily revenue based, should also remain higher on average than Basel III computation, especially for trading operations.

Inconsistencies In Basel III Implementation Look Set To Continue

We believe that the G20 leaders have taken a very clear stance toward implementing regulatory reforms in the global banking system. In particular, we expect significant improvements in the global consistency of the regulatory capital definition. Nevertheless, we believe that the likelihood of continued material discrepancies in Basel III implementation on a national basis is relatively high. For example, the Swiss regulator seems likely to implement more demanding capital requirements with shorter transition periods than those currently contemplated by the Basel III framework.

We consider that some regulators may wish to accelerate or slow down the implementation process depending on the health of their local banking industries and their performance during the crisis. The more demanding Basel III regulatory regime may, in our opinion, be implemented in a more or less stringent way across the globe. Likewise, we anticipate that differences in regulatory risk weights will remain as much driven by differences in banks’ risk profiles than by variation in the methodology used (for example, differences in internal models or in regulatory approaches) to assess the risk weights.

In order to maintain international comparability and transparency in our approach, we expect to continue applying our standard risk weights to credit, equity, and operational risk exposures as we believe that internal models are too specific for a like-for-like comparison. Despite our RACF being less granular and issuer-specific than internal-rating-based Basel ratios, we believe that it will remain a more consistent starting point for our capital analysis globally than those ratios under Basel I, II, and III.

FROM http://www.standardandpoors.com

For a complete copy of tables and appendix, etc go to:

 http://www.standardandpoors.com

Chinese Central Bank Response Calls the USA Quantitative Easing 2 – ‘A Huge Risk and Likely To Create Another Crisis’

BEIJING – Unbridled printing of US dollars is the biggest risk to the global economy, an adviser to the Chinese central bank said in comments published, a day after the Federal Reserve unveiled a new round of monetary easing.

China must set up a firewall via currency policy and capital controls to cushion itself from external shocks, Xia Bin said in a commentary piece in the Financial News, a Chinese-language newspaper managed by the central bank.

“As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament,” he said.

Li Daokui, another academic adviser to the central bank, said loose money in the United States would translate into additional pressure on the Chinese yuan to appreciate.

“A certain amount of capital will flow into China, either through Hong Kong or directly into the mainland,” Mr Li said.

But he added that Beijing would stick to its own gradual pace in managing the yuan’s rise.

He also said that big gains in US midterm elections by Republicans, who are seen as more friendly to free trade, had made him “a bit relieved” because political calls for China to let the yuan rise would likely quiet down.

The Federal Reserve launched a fresh effort on Wednesday to support the struggling US economy, committing to buy $US600 billion ($A600 million) in government bonds despite concerns the programme could do more harm than good.

Policymakers from emerging market powerhouses in Latin America and Asia said they would come up with fresh measures to curb capital inflows following the Fed policy.

Wang Zihong, a US-focused economist at the Chinese Academy of Social Sciences, a top government think tank, said the US quantitative easing could add to inflationary concerns in China.

“It will put pressure on the dollar to weaken, thus pushing up global commodity prices, including oil. So it will increase imported inflation pressure in some countries, including China,” he said.

What is the Best for China?

But Mr Wang dismissed suggestions that China might sell some of its vast stock of US Treasuries as a way of punishing the United States and cutting Beijing’s exposure to US dollars.

“This is an emotional proposal. What will China buy after selling Treasuries? Do we have any idea? No, we are unable to think out an idea,” Mr Wang said.

Mr Xia, the central bank adviser, said that it will take a long time for the global monetary system to improve and that China must be ready to hold the line on its currency policy and capital controls.

“We must keep a clear mind. We must not lead the world in financial regulation, nor simply follow the deeds of mature economies. We must think ‘what is good for us’,” he said.

China already has a regime of tight capital controls in place, limiting its vulnerability to the wave of liquidity that analysts say could be pushed towards emerging markets by easier US monetary policy.

By closely managing the yuan’s exchange rate, Beijing has also been able to blunt appreciation pressure in the face of a weakening dollar.

To better coordinate its policies, China should establish a team in charge of broad economic and financial supervision above its current network of financial regulators, Mr Xia said.

As an academic adviser on the central bank’s monetary policy committee, Mr Xia does not have decision-making powers but does provide input to the policy-making process.

First Home Buyers Revive Flagging Property Market

First home buyers have revived the Australian property market.

The danger is that many may soon find the excitement of owning their own place short lived as job losses rise, house prices fall and instances of negative equity grow.

Of course such a view is not shared by many; however there is need for caution.

Australian Finance Group (AFG) the aggregation group for MacLean Finance Pty Ltd settled 7,673 mortgage loans in February 2009, of which 26.1% or 2003 were for first home buyers. (The Australian Bureau of Statistics housing finance data which lags behind by a month, indicates that AFG accounts for a tenth of all mortgages lent in Australia)

Naturally the increased government grants for first home buyers has without doubt provided a stimulus, evidenced in AFG figures with 4,786 first home buyers in the three months to February 2009 –which is more than double the 2,316 for the corresponding period a year before.

Loan to value ratios – LVR, which is the loan expressed as a proportion of the value of a property, were 76.6 per cent and 75.0 per cent for New South Wales and Victoria respectfully, which AFG said were higher than normal due to the impact of first home buyers, who usually have smaller deposits.

AFG’s February average for all mortgages was $349,000, with borrowers selecting the low variable rates, with only 2.5 per cent of new mortgages being fixed, even though Australian banks have already indicated passing on any more Reserve Bank of Australia official rate cuts will be difficult due to currently high funding costs.

The facts show that first home buyers are borrowing more than ever before, spurred on by government grants and falling interest rates, at a time when the global financial system is imploding, which may have further negative impacts on the Australian economy, is another sign to proceed with caution.

The Australian Bureau of Statistics indicates job security continues to slide, with Australian unemployment in January 2009 increasing to 4.6 per cent, up from 4.1 per cent a year earlier.

Reserve Bank governor Glenn Stevens provided some positives in his monetary policy speech last week, saying, ‘The Australian financial system remains strong and the monetary policy transmission process is working to deliver large reductions in interest rates to end borrowers’. This is reinforced with the Australian big 4 Banks now being listed amongst the top 14 Banks in the world.

Stevens also pointed out that, ‘Nonetheless, economic conditions are clearly weak, and given the speed and scale of the global economic deterioration and its effect on confidence, weak conditions are likely to continue in the near term’.

With unemployment rising, weak global economic conditions, and unsustainably low interest rates, Australia suffers the potential problem of enticing the financially inexperienced to load up with future levels of unserviceable debt, which is what landed America and the world’s financial system in this financial mess in the first place.

The answer for Australians is that the Banks continue with their conservative lending policies, – there is only one lender still lending 100% loans and doing so under very strict conditions – others have dropped their LVRs to 90% and 95%.

Credit impaired borrowers have greater difficulty in getting their loans approved compared to 18 months ago, which is a further evidence of the tighter and more conservative lending market currently operating in Australia, and most of the world.

The interest rate used to qualify borrowers is always loaded by the banks at 1.0% or 1.5% above current rates to ensure they can service their debts once rates move back up. A sound move by the Banks!

If you planning on becoming a First Home Buyer and your employment is secure, press ahead with your plans and take advantage of the opportunity to get into your own home. Being King of your own Castle is still a realistic goal for young Australians.

Weak building approvals to persist into 2009

Building approvals throughout Australia

were again weak in October and are

expected to remain so for much of 2009.

 

Yesterday’s data released by the ABS showed

total building approvals fell 5.4% in October,

and when seasonally adjusted, 26.1% down

on the previous year.

 

Multi-units fell a sharp 11.1% and  

are now down by 37% on October 2007.

 

Master Builder’s chief economist Peter Jones

predicted such weak building activity would

follow through into much of the new year.

 

“Stimulatory effects of the dramatic

loosening of fiscal and monetary policy

will take time to come through and

soft conditions in the housing market

can be expected over much of calendar 2009,”

Peter Jones said.

US Sub-Prime Market impacts Japan

The knock-on effect from the US sub-prime market

shows no sign of letting up in Japan.

In the last 7 days the Origami Bank has folded,

Sumo Bank has gone belly up and

Bonsai Bank announced plans to cut some of its branches.

Yesterday it was announced that Karaoke Bank is up for sale

and will likely go for a song,

while today shares in Kamikaze Bank were suspended

after they nose-dived and

500 back office staff at Karate Bank got the chop.

Analysts report that there is something fishy going on at Sushi Bank

and staff fear they could get a raw deal.

Australian observers have noted that the Whale Fleet Bank

has been in for a lot of blood letting.

Shocks from the Market meltdown

continue to be felt around the world.