Financial Crisis

[OneRedArmy]

Eg. the minimum cash reserve that a UK bank was reduced from 20.5% in 1968 down to 3.1% in 1998, at present it is a voluntary%.Are you sure?

AFAIK its broadly 8% of risk weight assets (loans) in capital (cash and cash equivalents [liquid securities]). So depends hugely on the riskiness and composition of the individual bank's loan book.

And thats an EU Directive, not an FSA-specific regulation.

As an aside, if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

[geysir]

I got to
/Reserve requirement (http://en.wikipedia.org/wiki/Reserve_requirement)

from this
Fractional reserve banking (http://en.wikipedia.org/wiki/Fractional-reserve_banking)
I was trying to understand the hows and the whys a Central bank prints more money.

[OneRedArmy]

I got to
/Reserve requirement (http://en.wikipedia.org/wiki/Reserve_requirement)

from this
Fractional reserve banking (http://en.wikipedia.org/wiki/Fractional-reserve_banking)
I was trying to understand the hows and the whys a Central bank prints more money.http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm

This is what governs how much capital European banks hold. Look for the Capital Requirements Directive.

The relationship to the amount of printed money is circulation is as remote as to be irrelevant IMHO.

[pete]

As an aside, if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

I presume by this you mean the punt would be monopoly money?

I think I heard that Icelandic currency is worthless outside the country which is making it difficult to import any goods including food. I guess everyone is on a fish only diet...

[OneRedArmy]

I presume by this you mean the punt would be monopoly money?

I think I heard that Icelandic currency is worthless outside the country which is making it difficult to import any goods including food. I guess everyone is on a fish only diet...Yeah, punt would be worthless as it would've been hugely devalued.

A quick look at individual and macro leverage (indebtedness/loans to deposits) measures show us as being next worst to the Icelandics, with the Brits also up there as well.

[Stuttgart88]

I think the Danes had an even bigger real estate bubble than we had & some of their banks have Baltic and other EM exposures.

My dad has some money on deposit with National Irish which is protected under the Danish scheme, not the Irish one, beacuse they're owned by Danske Bank. I'm going to tell him to move it. The Kroner is getting hit and today they've put rates UP in Denmark to try and protect the currency.

Total capitulation again in the markets today. Rumours that GM will file for Ch11 today. Currencies are all over the place. Credit markets getting hammered. The great deleveraging (i.e., selling of assets financed by debt because the lenders want their money back) is gathering pace. There will be massive hedge fund casualties.

Credit getting hit particularly hard. This really could be a vicious death spiral: fundamentally solid and cash generative companies may go to the wall because their banks won't refinance their loans and the bond markets are closed. Bankruptcies and credit downgrades will therefore gather pace. This'll make banks even less likely to lend and so on.

There were many bad stats out this morning but this one stood out for me: Vovlo sold 41,000 trucks in Q3 2007. In Q3 2008 they sold 115!

The 30 year swap is trading through US treasuries - ok, this is a technical thing - but though it can be explained it was previously thought not just highly unlikely but "impossible"!

Nouriel Roubini's speech in London yesterday is worth watching. The gloomy war prophecies we touched on here 2 weeks ago were even mentioned!

http://www.rgemonitor.com/blog/roubini/254130/bloomberg_october_23_2008_roubini_says_panic_may_f orce_market_shutdown

[pete]

The world economy is getting worse by the day now. Don't know where it is but the sooner we hit the bottom the better as can't plan recovery until we get there.

It seems one the problems with coming off property bubble into recession is that won't be another property bubble to back the boom days. I wonder what the next bubble will be caused by. We have just had IT & Building. Maybe renewable energies?

[geysir]

http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm

This is what governs how much capital European banks hold. Look for the Capital Requirements Directive.

The relationship to the amount of printed money is circulation is as remote as to be irrelevant IMHO.
I was only giving an example of one regulation that was changed, re cash reserves.
You asked was I sure.
I pointed out the link to you.
No one ever says thanks :)

[Stuttgart88]

The world economy is getting worse by the day now. Don't know where it is but the sooner we hit the bottom the better as can't plan recovery until we get there.

It seems one the problems with coming off property bubble into recession is that won't be another property bubble to back the boom days. I wonder what the next bubble will be caused by. We have just had IT & Building. Maybe renewable energies?Premiership football?
What happens if BSKY or Setanta can't refinance their debt, or the football clubs themselves?

[geysir]

Why would Renewable energies be regarded as a bubble to burst?
Is it subsidised to make the Kw price competitive?

On the surface it ticks some important boxes, it is local based, creates labour, less imports.

[passinginterest]

Why would Renewable energies be regarded as a bubble to burst?
Is it subsidised to make the Kw price competitive?

On the surface it ticks some important boxes, it is local based, creates labour, less imports.

I think Pete is suggesting that renewable energy might be the next big boom industry. Which we'll then allow our economy to become massively over dependent on and when energy markets suffer a decline the country will go into meltdown, perpetuating the cycle.

[geysir]

I see.
Still, investing in something that reaps benefit on so many hard core aspects is a solid enough investment also that type of investment is spread out over different types of renewable energy, diversifying dependance.

[pineapple stu]

Premiership football?
What happens if BSKY or Setanta can't refinance their debt, or the football clubs themselves?
Similar to the ITV Digital collapse, I suppose. Clubs going into adminstration all over the place, but ultimately surviving, albeit much cut back.

[pete]

I think Pete is suggesting that renewable energy might be the next big boom industry.

Yes. It might be a bubble but need something new to drag out of the slump.

Ireland is almost completely dependent on foreign multinationals with no significant local employers exporting products/services.

[OneRedArmy]

I was only giving an example of one regulation that was changed, re cash reserves.
You asked was I sure.
I pointed out the link to you.
No one ever says thanks :)Thanks for quoting the link, but it was wikipedia and wasn't particularly accurate and thats being kind :p

I see Stuttgart is calling capitulation, the problem is that you only know the bottom after the fact.

I've incorrectly called it twice so far!!!

The non-financial treasury market is very worrying (ABCP etc.). Banks need to be forced to lend to "real economy" companies as part of Government bailouts.

[geysir]

Thanks for quoting the link, but it was wikipedia and wasn't particularly accurate and thats being kind :p

AFAICS the Wiki reference to reserve requirement was accurate.
The statistics to the cash reserves requirement was quoted from the IMF figures.
The explanations on the Wiki may not be so accurate but I am not referring to those explanations.

AFAIU a bank's Cash Reserves is a ratio of cash held in reserve to deposits.
Bank hold in reserve a certain % of its liabilities (savers deposits)
It is the 3rd tool of monetary policy.
Imposed Cash Reserve requirements has the effect of putting a ceiling on Bank lending thus putting a ceiling on Bank's exposure to loans it gives out.
I would question when you say that the reduction in cash reserve requirements over the last 35 years for Banks is irrelevant.

[geysir]

The day after stonewalling the Brits attempts to hold every Icelander, man woman and child, bondage to a personal debt of approx £30k each and all that on top of insults and previous grevious injuries already inflicted, the Ice Gov signed a deal with the IMF for a loan of US$2bn.
I don't know what the terms are but the IMF guy sounds very positive about the 'bouncebackability' of Iceland :)
By my reckoning, that's a couple of months supply of heroin and B&B paid for.
There is some benefit to being first in the queue.
Apparantly for some reasons yet unknown, the survival of this Island is important for the survival of Western civilization.
Meantime, while we are on our mainline drip, we can listen to the long drawn out death rattle of the Celtic Tiger.

[mypost]

if Ireland hadn't joined the Euro (if me granny... etc.), we'd be Iceland Mark II. Thankful for small mercies etc...

That I find strange as the Brits never joined the Euro either. :confused: And I want them to join it.

[OneRedArmy]

AFAICS the Wiki reference to reserve requirement was accurate.
The statistics to the cash reserves requirement was quoted from the IMF figures.
The explanations on the Wiki may not be so accurate but I am not referring to those explanations.

AFAIU a bank's Cash Reserves is a ratio of cash held in reserve to deposits.
Bank hold in reserve a certain % of its liabilities (savers deposits)
It is the 3rd tool of monetary policy.
Imposed Cash Reserve requirements has the effect of putting a ceiling on Bank lending thus putting a ceiling on Bank's exposure to loans it gives out.
I would question when you say that the reduction in cash reserve requirements over the last 35 years for Banks is irrelevant.
Thats not correct, at least in the EU. Liquidity is pretty much self-managed. Loan to deposit ratios vary hugely. From around 100% for the more conservative savings banks to 280% for PTSB (Northern Rock was similarly high). Banks have been free to decide how much they leverage their book with market funding, within the constraints of the capital adequacy legislation I linked above.

[geysir]

I looked over that link but (my fault) I can't find a good table/graph/summary which sets out the minimum Capital Requirements (as in Bank cash or assets that can be quickly liquidised).
But I do find that the Directives (http://europa.eu/rapid/pressReleasesAction.do?reference=IP/06/797&format=HTML&aged=0&language=EN&guiLanguage=en) are blessed by Charlie McC. (sirens, alarms bells).
"A key aspect of the new framework is its flexibility. This provides institutions with the opportunity to adopt the approaches most appropriate to their situation and to the sophistication of their risk management."
That reads to me, as let the Investment/Lending Institutions work out what's best for themselves.

In general that system works until debtors forfeit their mortgages because the mortgage payments far exceed the value of the house for which they took the loan or/and their ability to repay is reduced. And this works okay until people lose confidence in their bank and want to withdraw their money or at least reduce their deposit.
At that stage you get a run on the bank, which - under such circumstances (the current circumstances) - is greatly undercapitalized. Two things can happen then. Either the bank collapses or someone (like the government) steps in to prop up the bank. But if the government does that - and the government itself is already in debt - then confidence might not be very high in this solution, especially when middle- and lower-income taxpayers realize that they are the ones who ultimately end up footing a bill that is likely (as past and present history shows) to only put more money in the pockets of rich and greedy investment institutions.

On another point, MMR?, what has the BOE done here in plain English?
from the BOE annual report 2007 page 36.
Banking Department balance sheet
'The principal reason for the increase in the Banking
Department balance sheet, £39.4 billion at 28 February
2007 (2005/06: £24.8 billion), was the introduction of
Money Market Reform (MMR) in May 2006. The new
framework is based on a reserves-averaging system, with
reserves-scheme participants electing to maintain a target
balance on average over a maintenance period running
from one MPC meeting to the next. These balances are
reflected in ‘deposits from banks and building societies’ on
the Banking Department balance sheet and have been
matched by an increase in the Bank’s lending via
short-term open market operations (OMOs), ‘loans and
advances to banks’. At 28 February 2007, around
£20.3 billion of Banking Department’s assets comprised
sterling money market refinancing provided through the
Bank’s OMOs (2005/06: £3.2 billion). The size of the Issue
Department’s deposit with Banking Department has
remained close to £50 million'.

[OneRedArmy]

I looked over that link but (my fault) I can't find a good table/graph/summary which sets out the minimum Capital Requirements (as in Bank cash or assets that can be quickly liquidised).].There isn't a good summary as its complicated. Very, very complicated. Broadly for large banks its internally driven by credit models which predict the probability of default, loss given default and exposure at default. See below.

But I do find that the Directives (http://europa.eu/rapid/pressReleasesAction.do?reference=IP/06/797&format=HTML&aged=0&language=EN&guiLanguage=en) are blessed by Charlie McC. (sirens, alarms bells).
"A key aspect of the new framework is its flexibility. This provides institutions with the opportunity to adopt the approaches most appropriate to their situation and to the sophistication of their risk management."
That reads to me, as let the Investment/Lending Institutions work out what's best for themselves. Broadly correct. They earn the right to self-determine their own regulatory capital based on a long and rigorous approval process by regulators which is subject to ongoing review. They are various floors, limits and other checks that ensure that capital is adequate.

These changes (known as Basel II) are only in the process of coming into force and are only bedding in so this crisis was too early to test them.


In general that system works until debtors forfeit their mortgages because the mortgage payments far exceed the value of the house for which they took the loan or/and their ability to repay is reduced.Not exactly, you use models to predict this and the problems occur when the models don't correctly predict the number and magnitude of defaults.
And this works okay until people lose confidence in their bank and want to withdraw their money or at least reduce their deposit. .Whoa, this is now liquidity risk, not credit risk, which is what you were discussing above.


At that stage you get a run on the bank, which - under such circumstances (the current circumstances) - is greatly undercapitalized. .No, does not follow. A bank run will kill any bank, regardless of their loan profile. To date, its been fear of future credit losses that have caused liquidity issues, not actual credit losses.

The whole premise of the western banking system over the last century or so is that bank runs are rare (e.g. 150 years since the last one in the UK pre-Northern Rock) and that either


the bank collapses or someone (like the government) steps in to prop up the bank.Obviously the events of the last year have caused the whole area of liquidity risk management to be completely re-defined and its likely, that when the dust settles, a more quantitative approach to liquidity management will emerge. But its too early for that to be realistically be expected at this stage.

[Bald Student]

Having not understood any of that, can someone tell me whether the losses the banks are likely to make over the next few years will be greater or less than the profits they've accumulated over the last few years? That is, were they gambling their own money or depositors money?

[OneRedArmy]

Having not understood any of that, can someone tell me whether the losses the banks are likely to make over the next few years will be greater or less than the profits they've accumulated over the last few years? That is, were they gambling their own money or depositors money?Depends how much depositers money is left in the bank and what the credit losses are!

If you take the extreme example and assume every loan a bank has extended isn't repaid, then yes, this won't cover savings. Obviously this example is as extreme as to be irrelevant, but then we just get into arguing about the future level of credit losses and deposit gains and losses.

[Bald Student]

Depends how much depositers money is left in the bank and what the credit losses are!

If you take the extreme example and assume every loan a bank has extended isn't repaid, then yes, this won't cover savings. Obviously this example is as extreme as to be irrelevant, but then we just get into arguing about the future level of credit losses and deposit gains and losses.
Why would it depend on how much depositors money is left in the bank?

If I may ask a simpler question then, do we know what the accumulated profits of the banks are?

[pete]

Iceland Interest Rate increased to 18% today. Inflation running at 15% apparently. :eek:

Need to put in a foot..ie change request for detailed financial jargon filter :p

[OneRedArmy]

Why would it depend on how much depositors money is left in the bank?

If I may ask a simpler question then, do we know what the accumulated profits of the banks are?Remember that banks have historically paid out a sizeable percentage of their profits immediately as dividends to shareholders so they don't carry huge retained profits year on year.

Therefore the retained profits, along with the rest of the capital base, is nowhere near enough to pay back all deposits, credit losses or no credit losses. This isn't just an Irish issue, banks, in general, cannot repay all depositors if they all land on the doorstep at any given time. This is liquidity risk (the fact that there is a maturity mismatch between a banks assets [loans] and its liabilities [deposits]). You phrased it in the "are they gambling the depositors money" way. The broad answer to this is yes, thats what banking is all about. Banks earn a risk premia (profit) as depositors demand a certainty over the security of their deposits, whilst their is an inherent risk of non-repayment in each and every loan a lender writes. Thats credit risk. How banks fund and leverage their loan book impacts their liquidity as the more assets they hold in cash or liquid instruments reduces the amount they can loan out for better return.

So banking by its nature is a large balancing act, that is firmly based on past experience as a guide to the future. And just like the ad says, sometime past performance is no guarantee of future return, and in this case it wasn't.

"one in one hundred" or "tail event" are words you'll hear very often in finance. They refer to the likelihood of a particular event occuring as being 1%, i.e. on average once a century.

This is important, as the closer you move to the tail (the unlikeliest of events) the more it costs to ensure the event doesn't happen, and on a marginal basis, the marginal cost increases hugely.

Therefore many banks over the last 3-5 years stressed their portfolios to cope with a 1 in 10,25 or even 1 in 50 event. What we are going through is widely acknowledged as a 1 in 100 event that very few banks (if any) would've planned for as the cost of protecting themselves against it would likely have been too onerous and uncompetitive to bear unless all banks globally were forced to do the same.

I'm trying to make this an uncomplicated as possible, obviously failing somewhat, but in some areas it isn't easy to explain. I've been working at it for coming up on 10 years and I'm still learning every day.

[Student Mullet]

Would it be correct then to say that the banks will likely make a loss of more than their accumulated profits, requiring them to get money from somewhere, like the government, to make up the difference?

Also, do we know what those accumulated profits are?

[OneRedArmy]

Would it be correct then to say that the banks will likely make a loss of more than their accumulated profits, requiring them to get money from somewhere, like the government, to make up the difference?

Also, do we know what those accumulated profits are?What will force a capital injection (probably underwritten by Govt) is for losses to reduce the capital ratio to an unacceptably low level. Very broadly, capital is made up of shareholders equity & cash-type instruments.

As stated above, accumulated profits are an irrelevance when they have been paid out to shareholders they can't be returned.

Have a look at the annual report of any of the large banks on their websites for more info on the composition of balance sheet & the annual P&L.

[Student Mullet]

Very broadly, capital is made up of shareholders equity & cash-type instruments.Thanks, I think that's the point that had me confused. Is it correct then to say that capital includes money that the bank has on deposit?

In my simplistic model of the situation I've divided the money in the bank into two categories. The first is money that belongs to the bank like accumulated profits (minus whatever they've given back to shareholders) and the second is money that the bank is minding for someone else like peoples deposits or a loan from another bank.

The point of my questioning is to find out whether the losses that they're likely to make is greater than the amount of their money that belongs to them because if it is they'll have to dip into the second pool to make up the difference.

Unless I'm misunderstanding you, you're using the word 'capital' to describe a mix of both types of money.

[shantykelly]

Therefore many banks over the last 3-5 years stressed their portfolios to cope with a 1 in 10,25 or even 1 in 50 event. What we are going through is widely acknowledged as a 1 in 100 event that very few banks (if any) would've planned for as the cost of protecting themselves against it would likely have been too onerous and uncompetitive to bear unless all banks globally were forced to do the same.

in engineering we call that storm events, and the recent meteorlogical problems in ireland with floods and what not give you an indication of how good are preparations against these events are.

[OneRedArmy]

Thanks, I think that's the point that had me confused. Is it correct then to say that capital includes money that the bank has on deposit?

In my simplistic model of the situation I've divided the money in the bank into two categories. The first is money that belongs to the bank like accumulated profits (minus whatever they've given back to shareholders) and the second is money that the bank is minding for someone else like peoples deposits or a loan from another bank.

The point of my questioning is to find out whether the losses that they're likely to make is greater than the amount of their money that belongs to them because if it is they'll have to dip into the second pool to make up the difference.

Unless I'm misunderstanding you, you're using the word 'capital' to describe a mix of both types of money.Firstly, there aren't two separate pools of money.

So broadly yes, banks are lending your money out and if a sufficient number of borrowers fail to repay borrowings (would need to be fairly sizeable to exhaust the capital buffer) then depositors money is at risk.

But bear in mind all this is dynamic and banks can raise deposits and reduce loan volume to provide additional coverage.

In practice what will happen is that the capital ratio will go below acceptable tolerances well before this happens and the banks will be required to get a capital injection. As happened in the UK.

[Student Mullet]

I think either I'm not understanding you or you're not understanding me and, given our levels of knowledge on the issue, it's probably the first option.

My highest level of education in these matters (Junior Cert. Business Studies) used a definition of capital different from the one you're using. My notion of capital wouldn't include depositors' money but you're telling me that money which belongs to the bank can't even be conceptually separated from deposits and that's what has me confused. When I'm doing my own finances I look on money I own myself (from my grant or wages) as very different to money I borrowed but have to pay back, I don't see why the banks wouldn't draw a similar distinction.

When I saw the financial regulator on Prime Time he said that there's nothing to worry about because the banks have capital of 40 billion, or some other really big number. That put me at ease because I thought that, no matter how bad things get, there's no way that the banks could loose that amount of money. Now you're telling me that the big figure isn't what I'd call capital but mostly made up of depositors money. That brought be back to my original thought, do the banks have enough of their own money to cover their losses. I'm open to the possibility that I'm wrong and everyone who works in the world of finance is right but it seems to me that what should be the key number in all of this is being ignored in favour of long, complicated descriptions.

[Poor Student]

My highest level of education in these matters (Junior Cert. Business Studies) used a definition of capital different from the one you're using. My notion of capital wouldn't include depositors' money but you're telling me that money which belongs to the bank can't even be conceptually separated from deposits and that's what has me confused. When I'm doing my own finances I look on money I own myself (from my grant or wages) as very different to money I borrowed but have to pay back, I don't see why the banks wouldn't draw a similar distinction.

Customers' deposits have two a two fold effect with the bank. The cash deposited is now an asset of the bank but it is also recorded on the balance sheet as a liability owed to the depositers. I don't have a fraction of ORA's understanding but I don't know if that helps.

[pineapple stu]

Yeah, that'd be correct.

I would imagine (and this is from an accounting background, not a financial background) that when the Financial Regulator says the banks have capital of E40bn, that's the nett capital per the balance sheet. This is everything the bank owns minus everything it owes. Going purely by this, deposits are irrelevant as the bank both owns and owes the money as Poor Student said. I agree that sounds like an awful lot of money to lose.

Where the worrying starts is if the bank runs out of cash, not capital. This would create a problem because, even though the bank may still be trading OK, you wouldn't want to put your PASS card into the machine, ask for E200 and have a computer come out to you.

Overall so, cash - be it the bank's or depositors' - can't be separated if you're worrying about liquidity (cash), but it can if you're worrying about capital. But liquidity is the one you really want to be keeping an eye on.

[Bald Student]

Yeah, that'd be correct.

I would imagine (and this is from an accounting background, not a financial background) that when the Financial Regulator says the banks have capital of E40bn, that's the nett capital per the balance sheet. This is everything the bank owns minus everything it owes. Going purely by this, deposits are irrelevant as the bank both owns and owes the money as Poor Student said. I agree that sounds like an awful lot of money to lose.

Where the worrying starts is if the bank runs out of cash, not capital. This would create a problem because, even though the bank may still be trading OK, you wouldn't want to put your PASS card into the machine, ask for E200 and have a computer come out to you.

Overall so, cash - be it the bank's or depositors' - can't be separated if you're worrying about liquidity (cash), but it can if you're worrying about capital. But liquidity is the one you really want to be keeping an eye on.

Everything you've said there is what I used to think before I read what the Derry fan had to say. He says that in this case capital includes both shareholders capital (am I using that phrase correctly, what I mean is money from the sale of shares plus profits minus dividends?) and 'other cash instruments'. That second thing sounds like it means people's deposits as well but I could be wrong.

I'm not particularly worried about the Banks having a liquidity problem. That strikes me as a short term issue, if they have the assets to cover what they need they'll find the money from somewhere, even if it's a temporary loan from the govt.

I'd be much more worried if they were insolvent because that puts the depositors/governments money at risk.

I looked up BoI on google and it said that it has a net equity of 6.5 billion. Would it be a correct reading of this to say that the BoI can loose 6.5 billion before becoming insolvent?

http://finance.google.com/finance?q=NYSE:IRE

[OneRedArmy]

Everything you've said there is what I used to think before I read what the Derry fan had to say. He says that in this case capital includes both shareholders capital (am I using that phrase correctly, what I mean is money from the sale of shares plus profits minus dividends?) and 'other cash instruments'. That second thing sounds like it means people's deposits as well but I could be wrong.

I'm not particularly worried about the Banks having a liquidity problem. That strikes me as a short term issue, if they have the assets to cover what they need they'll find the money from somewhere, even if it's a temporary loan from the govt.

I'd be much more worried if they were insolvent because that puts the depositors/governments money at risk.

I looked up BoI on google and it said that it has a net equity of 6.5 billion. Would it be a correct reading of this to say that the BoI can loose 6.5 billion before becoming insolvent?

http://finance.google.com/finance?q=NYSE:IREI'm loathe to quote wikipedia but in the absence of a better explanation that doesn't involve an EU directive (see a few pages back)
http://en.wikipedia.org/wiki/Capital_requirement

Regulatory capital is a buffer. If the buffer is used up, deposits are at risk. Until it is used up, then they aren't.

The current situation is that the liquidity issue appears to have been addressed by Govt guarantee. This didn't address credit worries in the UK which forced UK Govt to underwrite equity investment to bolster the main banks capital buffer.

I still think it is likely that this will have to happen in Ireland sooner rather than later, despite people like Eugene Sheehy saying he'd rather AIB died that do an equity offer.

So, in summary, possible that depositors could lose if defaults were sufficiently catastrophic, in practice unlikely as Government would be forced to intervene well before capital buffer was exhausted.

[pineapple stu]

Everything you've said there is what I used to think before I read what the Derry fan had to say. He says that in this case capital includes both shareholders capital (am I using that phrase correctly, what I mean is money from the sale of shares plus profits minus dividends?) and 'other cash instruments'. That second thing sounds like it means people's deposits as well but I could be wrong.

When you get to large public companies, there's a couple of different ways of presenting accounts. I ignored that bit in college, to be honest, cos I knew it'd never be relevant to me. I think it all more or less comes back to the way I've outlined it, though (on the basis that two ways of describing the same thing can't really be different).

I think you're right about the E6.5bn. There's massive assets and liabilities because of all the deposits obviously (and stuff like houses that they own). You can also get BoI's accounts on www.CRO.ie. (It'll cost E2.50). Slightly more reliable than google, but it appears that that's the ultimate source for the link you provided.

[OneRedArmy]

Thats 6.5bn in the context of approx E150-200bn of total assets.

[pineapple stu]

Absolutely (and a similar amount of liabilities). But it's ultimately the answer to his question.

[Bald Student]

I'm loathe to quote wikipedia but in the absence of a better explanation that doesn't involve an EU directive (see a few pages back)
http://en.wikipedia.org/wiki/Capital_requirement

Regulatory capital is a buffer. If the buffer is used up, deposits are at risk. Until it is used up, then they aren't.

The current situation is that the liquidity issue appears to have been addressed by Govt guarantee. This didn't address credit worries in the UK which forced UK Govt to underwrite equity investment to bolster the main banks capital buffer.

I still think it is likely that this will have to happen in Ireland sooner rather than later, despite people like Eugene Sheehy saying he'd rather AIB died that do an equity offer.

So, in summary, possible that depositors could lose if defaults were sufficiently catastrophic, in practice unlikely as Government would be forced to intervene well before capital buffer was exhausted.

Thanks, I think the two of us are coming a bit closer together on this issue.

From that link, capital seem to mean roughly what I considered it to mean;


Tier 1 capital, the more important of the two, consists largely of shareholders' equity. This is the amount paid up to originally purchase the stock (or shares) of the Bank (not the amount those shares are currently trading for on the stock exchange), retained profits and subtracting accumulated losses.and there's also Tier 2 capital which allows for a few oddments like land re-evaluation to be included.

What you're saying to me so is that banks must have enough of their own money to cover 6% of their 'risk adjusted assets'. And that the banks will run into trouble, not when they run out of their own money but when they loose enough of it to drop below this 6% figure?

[OneRedArmy]

Tier 2 isn't worth tuppence in reality. Markets/Regulators are now targeting 6.5-8% core tier 1 as a "safe" amount.

This presents a problem for Irish banks.

[Bald Student]

Tier 2 isn't worth tuppence in reality. Markets/Regulators are now targeting 6.5-8% core tier 1 as a "safe" amount.

This presents a problem for Irish banks.

And Tier 1 is either cash they have sitting in a big safe somewhere (or whatever the equivalent means of storing money is) or stuff they've bought which they now own and which belongs to the bank and does not include any depositors money.

They must have enough of this to cover a potential loss of 6.5 to 8% of the loans they've handed out. The Bank of Ireland has 6.5 billion of this type of money and loans of 190 billion which means that they're nowhere near this 6.5-8% ratio. Because of this, they need to reduce the amount of money they have loaned out and that's why no one can get a loan from BoI at the moment?

[OneRedArmy]

Nearly! :D The ratio is based on Risk Weighted Assets, so it's not a flat 6 or 7% of total balance sheets assets.

If you think it's been complicated so far, working out RWA is a whole new beast!

[Bald Student]

Do risk weighted assets tend to be higher, lower or sometimes higher and sometimes lower than the figure for total balance sheet assets?

[OneRedArmy]

Do risk weighted assets tend to be higher, lower or sometimes higher and sometimes lower than the figure for total balance sheet assets?If I told you that I'd have to kill you ;)

Depends on the profile of the banks, ie what sectors it loans to and what the quality of its book is.

Also depends on whether it has permission to use its internal models to calculate RWA or whether it uses values provided by the regulatory authorities.

So sometimes higher, sometimes lower is the answer!

Not sure if the annual reports of banks provides RWA at the minute, certainly will have to going forward, in some granularity.

[Bald Student]

Sometimes higher, sometimes lower. Thanks.

Next question; if this figure tends to vary around the figure for total balance sheet assets, by how much does it tend to vary? Would they be in and around the same or can they differ by a lot?

Also; is it fairly safe to assume that the figure for Irish banks will be higher, given the state of the Irish property market?

Edit: Avoid phrases like "going forward, in some granularity". People might be tempted to assume that you're spoofing by using management speak, which I'm sure you're not.

[OneRedArmy]

Edit: Avoid phrases like "going forward, in some granularity". People might be tempted to assume that you're spoofing by using management speak, which I'm sure you're not.1) Thats the way people write in business
2) Frankly, I couldn't give a monkies what people assume!

As I said, its difficult to be anymore specific, without either giving out market sensitive information, or making sweeping assumptions/generalisations about other banks I don't have full knowledge of.

The Basel II Accord is really what you need to be reading for that level of detail
http://www.bis.org/publ/bcbs107.htm
but even with that, it doesn't get you much closer to what each institutions RWA is.

Edit: found this on the web
http://backup.aibgroup.com/errorpageimages/HalfyearlyPres2008pdf.pdf

[Bald Student]

In conclusion then, the numbers we need to judge for ourselves whether the banks are in trouble are kept secret so we'll have to trust our politicians to make the right choices.

[Stuttgart88]

The expression "going forward" is actually redundant in every context it's commonly used in. Think about it.

ORA, in the last page of this thread you mention the 1 in 100 event that banks collectively failed to anticipate. To what extent did VAR type models that attempt to quantify extreme events actually contribute to the mis-anticipation of risk? What I'm trying to ask is that as every bank used a similar framework and their framework was saying conditions are benign and at worst won't be that bad, the sheer scale of this misperception presumably ultimately led to its failure.

I met the person at [global rating agency] who developed their SIV rating methodolgy in the 90s. He said he quit as the SIV market grew because the same market value declines modelled when SIVs were merely a small part of the investment market could not be applied / assumed as the SIVs grew to dominate the market. He was right. Doesn't the same apply to VAR type risk assumptions?

[OneRedArmy]

The expression "going forward" is actually redundant in every context it's commonly used in. Think about it.

ORA, in the last page of this thread you mention the 1 in 100 event that banks collectively failed to anticipate. To what extent did VAR type models that attempt to quantify extreme events actually contribute to the mis-anticipation of risk? What I'm trying to ask is that as every bank used a similar framework and their framework was saying conditions are benign and at worst won't be that bad, the sheer scale of this misperception presumably ultimately led to its failure.

I met the person at [global rating agency] who developed their SIV rating methodolgy in the 90s. He said he quit as the SIV market grew because the same market value declines modelled when SIVs were merely a small part of the investment market could not be applied / assumed as the SIVs grew to dominate the market. He was right. Doesn't the same apply to VAR type risk assumptions?A lot of good points. A couple of things.

I think it was part "fail to anticipate", part "decide to accept the risk". Or to put it another way, the naive and the stupid.

Next, the models themselves, both market (VAR) and credit risk. In the absence of a time machine, a model is only is good as the data that was used to build it. Data gets patchier the further back you go and we have just come out of the longest period of positive economic performance the world has seen. Ergo, when a model tries to predict the future and it was built using overwhelmingly benign/positive data, then you have an immediate risk that the model can't really capture the downside.

Add in that modelling works a lot better in a world of normal distribution, rather than in the real world where tail events have proven to be fatter than people could've imagined.

And for the cherry on top, as you've identified, we've seen the modelling equivalent of groupthink, where most banks use the same model, which exacerbates every mistake by a huge multiple. This is because not only is everyone exposed to the same model risk, but as everyone is making the same broad decisions, which reduce the available risk premia, the only way to profit is to increase leverage again and again.

But, as I said previously, we have lots of new data to re-build models now :)