Caribbean Leverage Datapoint of the Day

March 17, 2009

Alea finds a speech from the governor of the Trinidadian central bank, which reveals that the country’s largest financial-services company, Clico, had assets of $24 billion but that local regulators required it hold just $3 million in capital. "This is what I call real leverage," notes Alea, drily: "8000/1".

Shortly after the Stanford scandal broke, I had brunch with a Trinidadian friend who was worried that just about all of Trinidad’s banks were offering CDs paying suspiciously high rates of interest — not just in local currency, but in pounds and US dollars too.

After taking a quick look at what was going on, I reckoned that Trinidad’s financial institutions, while they might have been unwise, were not criminal Ponzi schemes: the rates of interest they were paying, while high, weren’t substantially higher than the Trinidadian government’s own cost of funds. A Trinidadian depositor is naturally taking sovereign risk, and is being compensated for the fact that risk is high.

In general, it has never been riskier to have your deposits in a small country with its own currency — just look what happened to Iceland. When the currency is pegged to the dollar or the euro (eg Trinidad or Latvia) you’re not much safer: as we saw during the Asian crisis and in Argentina, currency pegs tend to disappear overnight in times of crisis.

It’s also worth noting that most of Citibank’s deposits are held in its foreign branches, are not insured by the FDIC, and are subject to the sovereign risk of the country where they’re deposited. Those depositors aren’t just taking Citibank risk: they’re taking increasingly-perilous country risk on top. If they decide to move their money somewhere safer, that could be a serious liquidity problem for Citi. It has built up a global franchise by being seen as something of a safe haven in small countries. As that reputation wanes, the value of its franchise likely wanes with it.

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