The regulators focus on the so-called ‘capital adequacy ratios’: they take the equity of a bank and compare it to what they consider the bank’s risk assets to be. Then they apply a minimum capital ratio, i. e. they might say that the bank’s equity must represent at least 9% of the bank’s risk assets.
That formula is fine and dandy and regulators world-wide seem to have become blind believers in it. There is only one catch to this formula: risk assets are less than total assets! The difference between risk assets and total assets are the so-called ‘risk-free assets’.
The regulators seem to be the only people in the world who have not yet come around to the logic that there is no such thing as a ‘risk-free-asset’. There are, however, such assets which appear or which are determined by the regulators to be risk-free. For example: it appears plausible to consider a US Treasury Bill as a risk-free asset. Is it plausible to consider a sovereign bond of Greece, for example, as a risk free asset?
One of the first things I was taught in banking was: “Assets are not always worth what the books show. Liabilities always are!”
Liabilities almost always are worth at least as much as the books show. Possible exceptions: provisions for loan losses and other risks might be a little higher on the books than in reality, but normally it is the other way around.
Thus, the traditional concept of ‘total leverage’ is, at least to me, just as important as the official minimum capital ratio. One has to bear in mind the bank’s funding risk. All assets must be funded, regardless of whether they are considered risk-free or not. The more the assets which are funded by liabilities instead of equity, the greater the funding risk. And, as the years since 2008 have shown, the funding risk can be greater than the credit risk. Much more so: the funding risk, once it hits, can trigger credit risk.
Below are the total leverage calculations for the above-mentioned four banks per June 30, 2012. The figures are in billions; in EUR for Deutsche Bank and in USD for the other three:
|Total Net Worth||56||173||191||185|
|Balance Sheet Total||2.241||2.652||2.290||1.916|
In the times before Glass-Steagall was put aside, the maximum total leverage which US Money Center Banks showed were around 20:1, and that was considered high. Today, only hedge funds show a total leverage of 20:1 or more. A hedge fund with a total leverage of 40:1 or more is considered as highly leveraged.
The above table would suggest that Deutsche Bank, from the standpoint of total leverage, is a very highly leveraged hedge fund. Certainly lightyears away from the other three banks.
Deutsche Bank is still considered the most stable financial institution in Germany, sort of the chief representative of ‘Germany, Inc.’. Is it really?