There has been much discussion in the financial media over the weekend about the supposedly perilous state of Credit Suisse and the not much better state of Deutsche Bank. Both have share prices that suggest the bank as a whole is worth about a quarter of the supposed net asset worth of their balance sheet.
This tweet makes it clear that they are not alone in having this undervaluation:
I see much crappy analysis of the #banking sector coming out of Twitter influencers with millions of followers. P/B has been falling industry-wide because book value up while price down. Hardly concerning. What matters is a bank's Risk-Based Capital, a difficult number to find. pic.twitter.com/op63oTXolm
— Timothy Peterson (@nsquaredmacro) October 2, 2022
What this does, of course, imply is that rationally the shareholders demand that the bank be broken up and that the assets be returned to them. That demand is not being made.
That implies something else. That something else is that the shareholders do not believe the asset valuations on the balance sheets of these banks, whatever their auditors might have to say about them.
The reason for this disbelief is not hard to find. The banks in question will hold the assets on their balance sheet at supposed market value. Whilst for some assets market value is relatively easy to find, for others it is not and discounted cash flow models based on expected future rates of return and expected interest rates will be used to determine these values. And that, in the current market environment is where the problem lies.
We know two things about expected future returns and interest rates right now. The first is that future returns are increasingly uncertain and need to have an increasing risk factor applied. The second is that interest rates are rising, pretty much everywhere, although not as much (maybe) as in the UK. In that case whatever market values were estimated not long ago could now be drastically overstated.
Three thoughts follow. One is that it is entirely possible that many banks are now sitting on entirely bogus balance sheets and that massive provisions against values are required.
Second, this means that the collateral many of these banks have to offer is severely diminished, potentially significantly increasing their cost of capital.
Third, mark to market accounting can exacerbate this trend by potentially reinforcing falls in value once poor market conditions as a result of increasing interest rates become ever more apparent.
What is the right policy response? First, to prepare to nationalise banks with no intention of returning them to the private sector.
Second, to cut interest rates as soon as possible as the policy of increased rates is clearly not working on inflation and is proving massively costly elsewhere.
Third, anticipate chaos because there is a real chance that a major bank might fail and they are all massively interwoven with each other, meaning the risk of contagion is high.
The chance of 2008 happening all over again looks to be significant as a result.
The real answer? Sound accounting and the ending of the use of many financial instruments that spread rather than mitigate risk in a downturn. Or to put it another way, go back to basics. This may be the only way out of this mess.
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Yes, it seems only a matter of time.
I’d suggest we create a new national bank, just like the proposed energy company by Labour. This bank will be basic, non speculative and non profit, and give everyone the ability to put their money in a safe government backed organisation. The government support for the commercial should then be gradually withdrawn. We need to break the link between the commercial banks and government
There is a great deal of sense in this
Thanks Richard
I believe we need to break the effective cartels that industries have, preventing a real market eg energy, water, banks, etc. The regulators are are NOT independent and are to biased towards the companies
By putting a nationalised company in the market would provide some real competition
As an aside why has no one taken the energy regulator to task as a UK specific energy problem is the paying non gas suppliers the same rate as the gas rate. This should be immediately decoupled, reduce the energy bills at a stroke and stimulate drive demand for green energy
What we really need is a dectralized bank. One that everyone has a decision in and not just the rich capitalist that reward themselves and no one else.
That is not going to work
Most people don’t want to make such decisions, for a start
Wholesomely agreed.
I agree.
The 90-95% of the population that just require somewhere safe to keep their money, maybe a savings account and the occasional loan desperately need a banking system that is entirely separate from the corrupt speculative jungle that banking has now become.
The obscenity of ordinary people, repeatedly having to bail-out the richest people on the planet because their private businesses are allegedly too big to fail needs to be ended as a matter of urgency.
As I understand it the 1930s Glass-Steagall act enforced such a split and made a major contribution to prosperity and equality in the west until the 1980s.
Under persistent attack from the rich until its final demise in 1999 we now have to live with the chaotic mess that has followed.
Yes – we used to have one; Giro Bank. (Destroyed by Thatcher for being too dangerous a competitor to her banking friends.)
In all essentials of life there needs to be a State provider that provides back-stop competition and also a mechanism for shaping the market. Banking, Water, Energy.
I see the merit of a “State provider”, that actually provides a universal, guaranteed safe asset home for bottowers and lenders alike. After all, the shakeout of our current crisis is likely to be home foreclosures in the future, as much as risk to savings (covered anyway up to £85,000, which is the only reason any High Street saver has any confidence atall after 2008). In the US it was the reality of foreclosure which foreshadowed the Tea Party, and Trump: In 2008 US Main Street discover Jimmy Stewart didn’t really run the local bank. Hollywood made films in the last decade, which played on the theme of midwestern foreclosure.
Nevertheless, I woould need to see the small print of how the State High Street bank “shapes the market”. My imagination falls over some way short of achievement of such an aspiration.
That’s correct Clive, it was my first bank account, did the job just fine. Flogged off to A&L building society, who eventually, via the demutulisation mess, went begging to Santander to be taken over for £1 due to the debts they’d accumulated in yet another financial sector disaster.
So now I’m with a Spanish private bank, having started off with a perfectly viable British state run bank. Down to the actions of the idiotic British political right, who like to shag the ******* flag whilst actually destroying genuine British institutions and companies.
Was there ever a truer word spoken abount politics than Dr Johnson’s (a REAL patriot unlike his worthless namesake) famous phrase?
But surely everyone knows that the private sector is so much better at identifying and serving the customer’s needs more efficiently than anything the state could so. And no one would want a competitor with the almost limitless resources of the state to crowd out the private sector.
We used to have other people owned banks. They were called Trustee Savings Banks. In my childhood I had an account at the Nottingham Trustee Savings Bank. Was it Thatcher who stole them all and sold them to Lloyds?
They were privatised first…
A great loss
Mr Walker,
Big Bang (1986) developed a chain reaction that ripped through, and effectively destroyed (laid waste) the whole mutualised financial sector; which accounted for a very significant part of the Scottish financial sector. These institutions had standards, were focused on the long term interests of depositors and were run, very often by actuaries; well paid, but not driven by fat bonuses and pure, personal greed. They breathed clean air.
The outstanding (high standard) Scottish Banking sector (protected long term by cross-holdings with City institutions that prevented take-over); were all destroyed by Thatcher’s Conservative Government (and the City, which is like a deadly virus). The major, independent Scottish Banks were faced with a non-negotiable choice after Big Bang. They could become major, typical, crude, City predators; or become prey to other City predators, and be eaten alive: but in either case, embrace what passes for ‘standards’ in the City. Different banks chose different routes to hell. The consequence? Total, abject catastrophe.
In the case of the Mutual Fund, Pension and insurance sector in Scotland) destroyed by the depositirs themselves in a display of unvarnished greed, with no interest in the long term economic consequences.
Thank you
I think the short answer is no, banks are not in trouble…. but these valuations are telling us something. Do note there are no US banks in there – JPM trades above book value and Wells Fargo close (ish) to Book value; also, Barclays is there but not Lloyds (80% of BV). These omissions may give as a bit of a clue what is going on.
Key factors are asset values (and prospects for asset values), Net Interest Margin and competitive landscape.
Asset values. The assets banks own are largely loans and bonds; the value of these goes up and down as rates move (although this risk is largely hedged) but, more importantly, with go up and down as the credit quality of the borrowers waxes and wanes. Some of these loans/bonds will be traded in liquid markets and will be recoded in the accounts at that price… but many loans are not traded – what value should be put on them? In practice they are priced at face value unless they are non-performing (in which case some estimate of recovery value will be made). In short, the Book Value will always be backward looking as it is unreasonable for accountants to put arbitrary values on performing loans. Also, banks are highly leveraged – 30% of BV does NOT imply most of its assets are only worth 30 cents on the dollar, rather that (assuming 10x leverage) that its assets are worth 93% of face amount (bad, but not that bad).
Net Interest Margin (NIM). This has been a disaster for European banks that dominate the list as negative interest rates have compressed (or completely eliminated) margins. The prospect of “low rates forever” has hurt European banks badly and although this is changing it is likely to be (to some degree) offset by impairment to asset values. I would also note in passing, interest payed on reserves (and not passed on to depositors) will restore bank’s fortunes quite quickly.
Competitive Landscape. Investment banking in Europe is a horrible business; fees are too low, the business is VERY cyclical and in the good times the bankers take all the money in bonuses leaving shareholders to pay the costs of restructuring in the bad times. Only in the US (where, in effect, a fee cartel operates) is investment banking a decent business.
So, in summary, market values are trashed for various reasons and shareholders are (and should be) unhappy…. but the rest of us should be fairly relaxed. Why? Because there is far more loss absorbing capital employed in the banking industry than ever before and it will do its job even if we see a repeat of 2008 (in terms of loan losses). Furthermore, regulatory (LCR and NSF) changes mean that an accident at one bank will not destroy the whole system.
If we are looking for the next disaster it will probably not be in banks. Although there will always be periodic banking crises (it’s the price we inevitably pay for maturity transformation) the last one is too recent and the protections put in as a result have yet to be sufficiently eroded (despite bankers best lobbying efforts). Look at insurance and pensions as falling asset values make it harder for them to meet obligations….
I hope you are right
I am not convinced
There are few certainties in life…. and to that short list I would add Banking Crises. They are inevitable. However, in ebb/flow of regulation/deregulation that tends to accompany banking crises we are still too close to the last one for the brakes to have really come off. Yes, I know the bankers have been lobbying hard to ease regulation but they have, as yet, been largely unsuccessful. One day that will change and then we should be afraid.
For now, we need to ask ourselves where has all the risk that was in the banking system has gone. That is where the next problem will lie….. and I think the inability of the market to absorb selling in the I/L government bond market last week suggests that liquidity risk lies with investing institutions.
As has been said
it all depends on confidence, the trick of inflationary “growth” rather than real.
The ridiculous inverted pyramid depending on the relatively few real workers in agriculture, making, construction.. “Financial services” even NHS, certainly not actually adding much value (wasn’t it in USA that half the health budget was keeping people alive that last year OF their lives?). Neither does the present government hence business people saying slim it down.
Richard, in the present circumstances you might see the £40bn p.a I suggested as too little, but at least it is a sure thing in Reducing Costs rather than, as Prof Congdon once said “froth” or Fluff. But the value of each home made eco-fit would be up by the £40k – which is where the £40bn p.a would be useful?
People seeing some light in EcoValue eventually coming their way = confidence?
Enough? [from 1 million homes and buidings made ecofit per year, i.e. £400m into banking extra p.a incrementally, £200 m incrementally to green and public educational benefit..]
PS Its really great what you are doing, Credit-creation-charge is a parallel subject to yours. commercial Finance needs fixing. Why not a 0.5% charge on special-purpose 20-year money that coud in a few years be extended, a solid platform. Could start that flow as a minimum adjustable example.. surely?
best regards, Ian G
To be candid Ian, I am not sure that I followed this
I’m sure I must have got something wrong, because who would not buy £1 for 24p? If the break-up value of the net assets really is more than their market valuation, why aren’t the banks being snaffled up and then broken up by vulture funds?
No doubt the banks have short liabilities and long assets, and the assets would sell at a discount in a fire sale, but a buyer could accept 50 pence in the pound and still make a lot of money.
Must we assume that the actual value that could be realised by selling the net assets is nowhere near the value in the books?
That is the only obvious answer
“That is the only obvious answer” might be true…. but answers are not always obvious and not the same for all banks. Your analysis is reasonable for (say) Bank of China but perhaps not for DB.
So, you buy up the bank shares at 30 (although you couldn’t get control of the bank at that price… but if you could) you sell the assets at 50… but who too? They will need to manage these assets and that managing infrastructure will look very much like…. errr….. a bank! …. and they have plenty of all this stuff priced at 30. If you try to sell to other investors they will just say “if I want that risk I will buy bank shares at 30”.
In reality, lots of banks are doing this already by a combination of an orderly run off of business which they want to exit and sales of positions where they able in order to become more transparent and valued at close to book.. They are then much more choosey about the new business they do (although I fear that some are making poor choices… and I accept this IS a risk).
The point is, the failure to do this arbitrage (buy bank, close it, sell assets) is less to do with the quality of the assets but more to do with the regulatory environment and for banks and institutional investors.
I’ve seen Clive’s reply, which makes a deal of sense.
The 2021 consolidated accounts of Credit Suisse show total assets of CHF 755,833 million and total liabilities of CHF 711,603 million.
The difference – the net assets – is about CHF 44 billion. And its current market capitalisation is about CHF 10 billion, which gives the ratio of price to book or a bit less than a quarter.
So, simplistically, the market seems to believe that the assets might pay off all CHF 711 billion of liabilities, but there might be only CHF 10 billion left over. That is about 95%.
That is if there is not assert liability timing mismatch, which there will be and which the markets are m,ost worried about, I suspect
Underlying this is the proposition that once “value” is questioned, and a crisis looms; everyone runs in the same direction, as best they can; at the same time. Liquidity is all, or as we used to say in the age before Big Tech – Cash is King.
Thanks to QE most UK banks have very large cash reserves.
Take RBS Plc (just RBS, not Natwest Group). Balance sheet at Dec 2021 of £106 billion. It has 35% cash reserves (£38 billion). It will earn them £855m in interest at current Base Rate.
Lloyds Bank Plc (just the bank, not Lloyds Group). £50 billion of cash reserves against £360 billion total current liabilities, which is about 14% (Dec 2021). They will get £1125m in interest at current Base Rate.
But we know those cash reserves only have limited uses
Sure, but they would deal with a bank run. If customers tried to remove e.g. £20bn from RBS and move it to another bank then they could do so. The RBS reserve account would still have £16 bn in it, and the £20 bn would just be distributed around the reserve accounts of other banks. Or RBS could ask for it in BoE notes and hand those out in branches. Lots of visible cash handed out slowly over the counter was the classic way to deal with a bank run.
Agreed
But that does not cover actual insolvency
“Or RBS could ask for it in BoE notes and hand those out in branches. Lots of visible cash handed out slowly over the counter was the classic way to deal with a bank run.”
There have been huge branch closures, compounded and multiplied by the digitisation of banking. Critically, this turns money into credit. It makes real ”cash” in a crisis more scarce. The Banks jumped quickly on Covid lockdowns to turn this into a permanent business advantage, and digitise wholesale, in their cost, overhead and profit margin interests. Meanwhile, the real use of notes and coin is in serious decline (the banks, I recall did not care for cash business, even in the 1990s). Cash is being squeezed out, driven by the Banks in their own interests.
I am trying to visualise the over-the-counter ploy now. How well would that work?
As an aside only, the real value of cash is quickly being lost; and this is especially problematic for the poor, those without bank accounts, or those with credit problems.
I recall Tim Gietner’s book on the crash of2008.He explained that the banks in 1931 took to stacking piles of dollar bills in their branch windows to reassure everyone they had plenty. End if the day it’s all a gigantic bluff, the only thing a bank has is confidence, once that is gone, it is lost.
I am also thinking the number of reserves in existence will save the banks this time. That and the fact that the central banks are much more aware and much more likely to intervene massively if the crunch came, with the usual emergency liquidity lending and suspension of mark to market rules (or at least a temporary easing of them) As Geitner wrote there is no point enforcing market rules when the markets are “irrational”. Of course, that brings us to the wider debate about whether our current banking system is fit for purpose. My view is that if the regulator has to periodically weaken rules and rescue it all because it is fundamentally unstable then it needs root and branch reform.
Mr Richardson,
Do you mean Tim Geithner, “StressTest” (2014), who was Treasury Secretary during the Obama Presidency? It is worth noting that Barofsky “Bailout” (2010), which is compelling; and whom was well placed, is scathing about Geithner’s Treasury and its support of Wall Street, especially over the toxic issue of foreclosures.
I keep referring back to the issue of mortgages and foreclosures right now, because the Conservatives are heading blindly under Truss-Kwarteng, in different circumstances, but in a major self-inflicted crisis-within-a-crisis, in the same catastrophic direction.
Hello John,
I did indeed mean Mr Geithner.
He did not condone the bailing out of the banks, rather taking the view that was necessary evil. The quote of the book for me was when he said that when such a major bank crisis occurs you have to put out the fire as fast as possible, which essentially means that you hose the whole thing down with vast amounts of money. (rather like a fire brigade). To keep the fire analogy going, he reluctantly added that even if that meant that you were also saving the “arsonists” who started the fire.
In his defence I would only say he was caught up in a problem not of his choosing and as a career diplomat (not a banker)
he took a pragmatic view of it all. He did not create the banking system that he regulated, so for me that is a huge admission (or condemnation) of the frailties of the system that we must address.
Dr Rideup,
Has the real (not nominal) value of bank cash reserves really gone up due to QE?
It’s hard to see a causation.
regards
Professor Carey
It certainly has. Before 2008 the banks typically had less than £40 billion in their reserve accounts. Today over £900 billion. Where else do you think QE money can go other than bank reserves?
Sound accounting………………….and more variety in interest rates that price risk/money use appropriately and specifically?
Although low interest rates to mortgage borrowers is good for a society where wages are falling, all the same low interest rates seem to do for casino bankers is make them even more stupid and bet the whole ranch!!
When will we learn?
What proportion of these banks’ assets is involved in fossil fuel extraction? Maybe it’s only a tiny part of their total value, but surely someone in their higher echelons must be concerned that fossil fuel extractors will be exposed and taken to court for wrecking the planet and endangering all our futures. These book assets would then be stranded and if justice were done, they might be very, very costly.
I’m not an accountant, but balance sheets have always been fascinating. When is an asset really an asset?
In any debt based money system, things may not be quite so tough if people spent all their money in the economy instead of saving it.
The trouble is, of course, that if a person has excess cash, what do they do? Buy multiple coffees, multiple meals, multiple homes? Nope, they may do the last one and buy a couple of holiday homes but otherwise, spare cash is saved or goes into assets.
Unless I’m mistaken, all deposits held at a bank are liabilities. If a bank has issued loans, they are assets. If the asset goes away because of bad loans, the liabilities remain. And so we get insolvency… Is my line of thought correct, I know it’s massively simplified?
Back in the good old days of the global financial crisis, there was one (almost) central bank that did a buy in. The Central Bank of Cyprus decided to recapitalise or more likely was told to by the powers that be. So they simply moved their liabilities from one side of the balance sheet to the other, and as if by magic they were assets.
I’m not clear whether they decided on what the cut-off point was, but seem to recollect 100,000 Euros.
https://bankofcyprus.com/en-gb/group/news-archive/Recapitalisation-through-Bail-in-and-Resolution-Exit-Bank-of-Cyprus-Announcement/
A claim was made via the European Court to get compensation, but this was refused.
https://www.reuters.com/article/us-cyprus-banks-idUSKBN1K3242
Let me read that stuff
In essence you get the balance sheet – but I think what you are confusing is liabilities and capital, both of which are credits