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 ©

Ordinary holders of bank shares had little idea that their investment was leveraged a speculative 50 to 1.

Sir, Daniel Davies, with respect to the lower returns on equity that result from higher capital requirements, holds that bank executives should tell investors: “You loved this business when it had equity-to-asset ratios of 2 per cent and a 16 per cent RoE. Why do you hate it now that it has 5 per cent equity to assets and a 9 per cent RoE?”, “Banks should not fixate on double-digit returns” January 13.

Let us be clear of that 2 percent equity to asset ratio signifies 50 to 1 equity leverage, and one of 5 percent, 20 to 1.

Does he really think shareholders loved the 16 percent RoE had they been truly aware that the bank management was leveraging his investment a mindboggling speculative 50 to 1… and taking home great bonuses because of that?

Does he really think shareholders would be satisfied with a 9 percent RoE if they really internalize the significance of banks now leveraging their investments 20 to 1, in times when any official assistance operations requires shareholders and creditors to first sustain important losses… in order for the management to keep taking home great bonuses?

Shareholders, like many other, were and are still misled by all those low leverages reported as a result of not using gross assets but using risk weighted assets instead.

Go back some years and you will, even in FT, find that the great majority of articles mention 10 to 1, or even lower leverages, quite often even ignoring to mention the risk weighing of assets, that which so much diminished the asset on which the leverages were calculated.

Would I be satisfied with a 9 percent RoE? Yes, perhaps for a bank leveraged 10 to 1… and with the bonuses to be paid to the managers decided by us, the shareholders. 

@PerKurowski ©

EDTF beware; disclosure requirements for banks can also be used as camouflaging material.

Sir, Oliver Ralph writes: “Maybe one day banks may be trustworthy enough not to have publish annual reports that are hundreds of pages long”, “Excessive disclosure by banks eludes comprehension” June 1.

Indeed but it is clear that publishing annual reports that are hundreds of pages long does not make banks more trustworthy either. One-way to concealed bad behavior, is to bury it under hundreds of pages of mumbo jumbo.

Ralph refers also to the Enhanced Disclosure Task Force’s (EDTF) “recommendation 7, which asks the banks to describe risks in their business models.” Would that cause banks to prepare their own homemade list of weights they assign to the risks in their business? That could shed some light on what risks the banks are not considering in their business model… but frankly, mostly it seems like generating profitable employment opportunities for bad and good fiction authors.

And I set all these efforts against the background of the regulators and the banks having colluded in producing that masterpiece of financial disinformation, which is the leverage that in the numerator does not use assets but risk-weighted assets instead.

Few days ago, a leading American newspaper, citing another leading American newspaper in its editorial expressed “banks are significant safer than they were prior to the 2008 financial panic, with an average of $13 in capital for every $100 in assets for member banks of the Federal Deposit Insurance Corp”. That is false! It should have stated for every $100 in risk-weighted assets; and it should have reported the real undistorted leverage too.

Since the risk weighing not only distorts information but also the allocation of bank credit to the real economy, something that is even more dangerous, the EDTF should start by clearing this out with the Basel Committee, before allowing banks more mumbo-jumbo material under which to hide.