Cushions are thicker but don’t get comfy

October 30, 2009

In a spot of good news for the economy, banks continued to rebuild their capital cushions in the third quarter. But are they doing so fast enough? One risk going forward may be the size of their securities portfolios, which could expose them to significant interest rate risk when the Federal Reserve finally taps on the brakes.

(Click table to enlarge in new window)


Measured by tangible common equity, the biggest banks are levered 20 to 1, a solid improvement from last quarter’s 24 to 1 and a giant leap from 30 to 1 in the third quarter a year ago. (These figures exclude off-balance sheet assets, which will increase leverage when they are consolidated beginning next year).

Tangible common equity is the crucial measure of bank capital because it is the primary cushion banks have to absorb losses. When it gets too low, creditors panic and bank runs ensue. From a systemic risk perspective, it’s great that banks are rebuilding this cushion.

The crucial question is how they’ll fare in a less favorable monetary environment. While consumer prices show little sign of inflating, asset prices are another story. Interest rates near zero have encouraged investors to chase risky assets. If that trend continues, the Fed may have to unwind its balance sheet and raise rates sooner than it would like, putting banks in a tough position.

FBR Capital Markets points out in a recent note to clients that many banks have poured excess liquidity into their securities portfolios, “which could present significant interest rate risk” when the Fed reverses course.

Compared with last year, the top 10 commercial banks have increased the size of their securities portfolios nearly 40 percent, with JPMorgan Chase’s rising over 150 percent.

And while securities prices are more immediately sensitive to monetary policy, loan portfolios would be impacted as well. Early next year, after the Fed turns off its printing press and after the home-buyer tax credit expires, real estate prices could resume falling. This will put more owners upside down on their loans, keeping default rates high.

Banks are extending loans, pretending that asset prices will recover past peaks, an unlikely prospect if the Fed does its job.

Now it’s up to regulators to deliver higher capital requirements so that banks can withstand the end of government support. After all, 20 to 1 leverage is still very high. It only looks prudent against the insane levels reached last year.


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The intra-quarter leverage ratios of these banks is tremendously higher than the end of Q reported numbers. Dont be fooled, the actual risks within the cap markets banks is even higher than before.

Posted by Oso | Report as abusive

I’m afraid the current reforms are a whoopee cushion.

Posted by Don the libertarian Democrat | Report as abusive

[…] Die Eigenkapitalausstattung der Banken verbessert sich, aber die Banken sind noch auf billiges Zentralbankgeld angewiesen (Rolfe Winkler). […]

Posted by “Die Sicherheitspuffer wachsen” • Börsennotizbuch | Report as abusive

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Posted by Casper | Report as abusive

[…] Cushions are thicker but don’t get comfy Rolfe Winkler […]

Posted by Links 11/2/09 « naked capitalism | Report as abusive

[…] chart from Rolfe Winkler’s Banks’ Capital Cushions: Thicker, But Still Not Comfy scares the bejesus out of me (Figure 1 and the quote […]

Posted by Decline of the Empire — Now What? :: ASPO-USA: Association for the Study of Peak Oil and Gas | Report as abusive

[…] chart from Rolfe Winkler’s Banks’ Capital Cushions: Thicker, But Still Not Comfy scares the bejesus out of me (Figure 1 and the quote […]

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