Friday, November 2, 2012

Which is the most dangerous bank in the world?

The Financial Stability Board has just announced the top-4 'too-big-to-fail' banks in the world: Deutsche Bank, HSBC, JP Morgan and Citibank. How dangerous are these banks really?

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:


Deutsche HSBC JP Morgan Citibank

Total Liabilities 2.185 2.479 2.099 1.731
Total Net Worth 56 173 191 185

-------- -------- -------- --------
Balance Sheet Total 2.241 2.652 2.290 1.916

Total leverage 39:1 14:1 11:1 9:1

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?


  1. One reason why some might consider DB the "most stable financial institution Germany" is because they perceive that there is little chance of the German people not agreeing to a DB bail out. There's no risk of Britain not bailing out the HSBC - but I wouldn't want to be occupying 10 Downing St at the time.

    Outside of Germany there are more than a few who think Deutsche Bank and Deutsche Bundesbank are one and the same - including some who should know better.

    The Federal Reserve Cleveland branch has done a study that suggests 'capital adequacy ratios' of up to 20% may be required.

    My father taught me "always assume you'll pay back what you borrow, and that you'll never get back what you lend." I think that's similar to your early lesson in banking - if not its stood me in good stead.


    1. Oh, I think you are right in saying that DB is 'German establishment risk' and could never be allowed by Germany to fail. That's exactly why I think the bank's strategy poses enormous risk for Germany. Chances that this risk will ever explode are, indeed, minimal but should that ever happen, then Germany will look back at the Hypo RealEstate bail-out as a light breeze on a nice spring day.