High bankers bonuses results from having to remunerate very little shareholders’ capital

Lex writes: “More than 700 high earners last year in Deutsche Bank were paid a weighted average of €1.9m a year”. July 11.

What would they be paid if the bank needed to hold 10% in capital against all assets? The equity minimization is the prime driver of high bonuses. 

@PerKurowski

The weaker Euro-nations pay quite a lot for Germany’s export advantages.

Sir, Paul Clifton writes about the advantages provided to German exports by the fact that other countries help to keep the Euro value down "The euro gives Germany a permanent cost advantage" August 23. That, which is entirely correct, should also have us refer to the disadvantages for those other.

In November 1998, just before the launch of the Euro, in an Op-Ed titled “Burning the bridges in Europe” I wrote: “The possibility that the European countries will subordinate their political desires to the whims of a common Central Bank that may be theirs but really isn’t, is not a certainty. Exchange rates, while not perfect, are escape valves. By eliminating this valve, European countries must make their economic adjustments in real terms. This makes these adjustments much more explosive. High unemployment will not be confronted with a devaluation of the currency, which reduces the real value of salaries in an indirect manner, but rather with a direct and open reduction of salaries or with an increase of emigration to areas offering better possibilities.”

And in November 2009, in a letter to you I asked about “what it would have looked like if for instance Greece still had the Drachma and Germany the Deutsche Mark… clearly Greece would be able to devalue and use that politically more friendly approach of being able to inflate yourself out of the problems, instead of having to impose "Germanic discipline" on their citizens.”

@PerKurowski

Like bank-managed risk based capital models, should children also set the nutrition values that determine their diet?

Sir, James Shotter writes about differences of opinion between American and European bank regulators, with respect to allowing big banks to use their own risk models to help determine how much capital they should hold. “Bank rules benefit only US, says Deutsche chief” November 19.

Sir, knowing that banks have huge incentives to reduce the capital they need to hold, in order to by means of higher leverages obtain the highest returns on equity possible, that is perhaps the greatest, but far from the only display of naiveté by the Basel Committee and the Financial Stability Board.

It is like allowing children to set the nutritional values that will determine their diet like for chocolate cake, ice cream, broccoli and spinach.

In this discussion the relevant question is: “European regulators, do you believe European banks to be genetically or by some other reason more disposed than US bankers to resist the temptation of high returns on equity and bonuses?”

If the answer is “Yes”, so be it, and then the market will evaluate that answer. My bet is that the market will long-term prefer better capitalized banks… as well as trusting more regulating nannies that trust less the children in their care.

“Valdis Dombrovskis, the EU’s financial regulation chief, said… he would not accept changes that significantly increased how much capital European banks had to hold.”

Is that so? Does he really want US banks to become stronger than the European under his watch?

Clearly there is a conflict between wanting the banks to hold more capital with wanting the banks to also serve the credit needs of weak economies. But there are ways to harmonize, like grandfathering any changes in the capital rules meaning leaving them as is for all the current assets of banks, and, for instance, applying a fixed 8 percent capital requirement for all new assets.

@PerKurowski

Banks, like Deutsche, to survive, need to move out of that artificial regulatory world of equity minimization

Sir, I refer to David Marsh’s narrative on Deutsche Bank’s troubles “German banking woes reflect shattered ambition and Schadenfreude” October 3.

There Marsh writes: “Throwing off its traditional conservatism, Deutsche Bank has moved into a realm of risk-taking where recklessness has ridden roughshod over rectitude”

Not exactly so. Deutsche Bank, like many, really like most banks, was moved into the=at artificial world created by regulators of avoiding risk-taking, since then it needed less capital, since then it thought it could earn the higher expected risk adjusted returns on equity that the market had been made to believe it should expect.

Before there is full understanding of the distortions that the credit risk weighted capital requirements for banks cause, there is little chance of finding sustainable solutions for the banks (and for the real economy).

Sir, there are many Deutsche Banks in waiting, just that they don’t know it, they just keep dancing to that lousy music the Basel Committee and the Financial Stability Board plays to them. As I have written to you many times before, banks must begin to maximize their returns on equity with banking, not with bank equity minimization.

@PerKurowski ©

Banks, to get out of their dead-end street, must make a convincing case they can prosper holding much more capital.

Sir, James Shotter, Laura Noonan and Martin Arnold write: “At yesterday’s close, investors were implying that the biggest bank in Europe’s most stable economy [Deutsche Bank] is worth €17.7bn, just a quarter of the book value of its assets.” And then we read of efforts to better that by reducing operations and cutting down on risk weighted assets. In other words being placed in an Incredible Shrinking Machine. “Big Read: Deutsche Bank: Problems of scale” July 29.

Because of the risk weighted capital requirements, banks were set on a road of increasing returns on equity by diminishing the capital they needed. And, on that road they lost many opportunities, like lending to “risky” SMEs and entrepreneurs. And they also ended up in dangerously over-populated safe-havens that, when compared to the “risky”, suddenly offer lower real-risk adjusted returns. They now are in a dead-end street.

So, if it was me, I would try to make the strongest case possible to my shareholders that there are good and safe returns on equity to be obtained by ignoring Basel regulations. “Give us 12 percent in equity, against all assets, so as to allow us pursue the undistorted highest risk-adjusted returns out there.”

Sir, I have of course no idea if that is a viable strategy for any individual bank, such as Deutsche Bank. Most banks are caught between a rock and a hard place. They need to ask for much capital, but that much capital might be so much, that they could scare away everyone. Anyhow, I would not like to work in a bank that is going to stretch out the suffering by asking for more capital, again and again, little by little. To get it all and get over it would benefit everyone, including current shareholders.

Is that impossible? Not really, here “one of the bank’s top 20 investors” is quoted with “The problem for Deutsche is that it has got to the stage where if it continues to cut assets, it is going to lose a significant amount of revenues”.

And on a different issue, the litigations and fines banks face, I repeat what I said over the years. 

When we all know that for the banks’ good and for our economies’ good banks need more capital, to extract fines paid in cash is irresponsible and masochistic. All those fines should be paid in shares.

@PerKurowski ©

The CET1 (common equity tier 1) divided by the leverage ratio, gives you a Gross Risk Hiding Ratio

Sir, James Shotter and Laura Noonan, while admitting that “the absolute level of the CET1 (common equity tier 1) is only part of the equation, they do compare Deutsche Bank’s CET1 with that of other banks. “Deutsche focus turns to towering task ahead.” February 10.

The common equity tier 1 ratio is calculated with the bank’s core equity in the numerator and with in the denominator the risk weighted assets, calculated with risk weights not assigned by me. So the safer the assets are perceived or deemed to be, the higher the CET1.

And the Leverage Ratio uses in the denominator the gross value (of most) assets.

As FT should know by now, I have always felt much more nervous about the assets a bank (or regulators) could perceive as very safe than with assets perceived as risky. And so I do give more importance to the leverage ratio than, for instance, to the CET1 ratio.

But the regulators would not allow us data on the leverage ratio, because, in their opinion, that would not reveal the real leverage to us and it would therefore only confuse us. And so they decided to credit-risk weigh the assets, and came up with the CET1 ratio or the slightly more generous Tier 1 Common Capital Ratio.

And of course that made many in the market feel much more comfortable with that the banks were quite adequately capitalized.

But one needs to adapt, and so I felt that new interesting ratios would be found in the market whenever the leverage ratio was published. And among these the CET1 ratio to the leverage ratio-ratio, because that ratio could be said to represent, the Gross Hiding Risk Ratio.

Though I admit I could be using wrong data, I found the following leverage ratios at end of 4th quarter 2015: Deutsche Bank 3.9; Goldman Sachs 5.9; Wells Fargo 8.0; and Morgan Stanley 8.3.

And if we take the CET1 ratios reported in the article and divide these by the leverage ratios we obtain the following Gross Risk Hiding Ratios: Deutsche Bank 2.85; Goldman Sachs 2.19; Wells Fargo 1.34 and Morgan Stanley 1.70

So if these calculations are correct then no wonder why Wells Fargo “is often described as the US’s safest banks [and] there are no [current] calls for a capital raising”… and no wonder Deutsche Bank faces quite bigger challenges.

@PerKurowski ©

How do you come up with a good bank strategy knowing current regulations are unsustainable and will change?

Sir, I refer to your reporters’ article on the fate of new chiefs grappling with problems at Barclays, Deutsche Bank and Credit Suisse “Banking trio seek clean sweep with investors” December 28.

For that capital that is supposed to allow banks cover for some unexpected losses, the regulators have imposed credit risk weighted capital requirements; more risk, more capital – less risk, less capital.

But, the excessive exposures that could endanger the bank system are never created with assets perceived as risky and always with assets perceived as safe.

But, the safer something is perceived, the larger is its potential to deliver unexpected losses.

But, to base some requirements for the unexpected on the expected credit risks, makes absolutely no sense.

But, since credit risk is about the only risk that is already cleared for by banks, with interest rates and size of exposure, clearing for it again in the capital, signifies that credit risks are given too much consideration and, any risk, no matter how well it is perceived, leads to wrong actions if excessively considered.

And so now we suffer from a catastrophic distortion in the allocation of bank credit to the real economy. Way too much credit to what is perceived or deemed to be safe, like in mortgages and to Greece, and way too little credit to what is perceived as risky, like to SMEs and entrepreneurs.

I am absolutely sure that this trio of bank chiefs, or at least some of those surrounding them, know that this kind of regulations are unsustainable and will be changed, hopefully sooner than later. Since any new regulations would most certainly entail holding more capital against all assets, something unwelcomed by their shareholders, the chiefs can’t even address this issue openly. It must certainly be no easy task to prepare for the ground moving beneath you.

@PerKurowski

When a banker reminds you of the importance of the simple things in life, you always worry a bit.

Sir, it is always slightly worrisome when a banker, no matter how correct he might be, starts reminding you about the importance of the simple things in life, like Bilal Hafeez of Deutsche Bank does, “Economists have a lot to learn from the ‘The Big Bang Theory’” July 22.

We might take some comfort in that Mr Haafez is a global head of foreign exchange research, and so seemingly has less to do with the day to day activities of Deutsche Bank :-)

How will markets react when informed that Deutsche Bank is leveraged 33 to 1?

Sir, Daniel Schäfer, on July 22, reports that Deutsche Bank is to cut assets for stricter capital rule aiming for a 3 percent loan to equity ratio. And “stricter” is there sort of laughable.

On January 2015, according to the Basel Committee, banks will have to report their straight leverage ratio. Can you imagine how Deutsch bank creditors, made aware they should not expect to be bailed out, will react when they read that Deutsch Bank is leveraged 33 to 1?

If 33 to 1 leverage is stricter, how flexible is it now?

We need to see the hiding-behind-regulatory-risk-weighting index of the banks

Sir Patrick Jenkins and Daniel Schäfer at the end of their “Banks in cash calls to meet Basel III” state the caveat with respect of the numbers shown that “Regulators [will] either raise risk-weightings and/or give more emphasis to nominal balance sheets.” Indeed, but it can also be, like the current crisis has clearly evidenced, that the risk-weights could also simply turn out to be very wrong.

And that is why I consider the illustration that shows Basel III core tier one capital ratios of 12 large banks to be quite opaque. As a minimum, next to each Basel III ratio they should have given us each banks capital to nominal balance sheet ratio.

That way, by dividing the first ratio by the second (or the other way round) we can build an index which allows us to identify how each bank hides behind risk-weights, whether these are calculated by themselves or by the regulators.

FT, John Plender, it was FIVE years ago that I told you “Simplicity in banking should always take precedence”

Sir, John Plender writes that Deutsche Bank’s net equity in 2007 amounted to just under 2 percent of total asset, meaning an over 50 to 1 leverage, while “its tier one core capital under the Basel weighted capital was 8.6 percent” which implies a lower than 12 to 1 leverage, “Simplicity in banking should always take precedence” December 7. 

As a consequence of not reading up sufficiently on what Basel II really was about you were duped. On my TeawithFT blog you can find hundreds of letters that tried to explain the Basel distorted bank leverages to you. You ignored these and even kept on again and again comparing the Basel risk-weighted bank leverages with the historic un-weighted bank leverages. 

And this amounts to a quite sloppy journalistic job and a general lack of questioning capacity in FT. 

And now on “simplicity” 

On December 19, 2007, John Plender, in “Investors pray for acts of God but even they come at a cost”, asked, what is the right level of capital for today´s financial world? 

And here is the answer to that that I wrote to FT, and to John Plender, five years ago: 

“Since it is in fact impossible to calculate the right capital then the best thing would be to be humble about it and require one single capital requirement on assets, instead of arrogantly trying to outwit the market as the regulators did when they created their current minimum capital requirements that differentiates based on how risks are perceived, primarily by the credit rating agencies. 

It is when the regulators themselves start acting like God that they really set us up for the big systemic disasters.” 

Does FT really have the "without fear and without favour" in it itself to recognize those who have been right all the time, even though these do not belong to FT’s own crony intimate circle?