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Following the crisis in Cyprus, which I talked about here, there has been a question about how much stress the banks can take during a bank run before their liquidity is at stake. A typical bank balance sheet looks like this (Figure 1):

(click to enlarge)

Figure 1: Balance Sheet

If the deposits get drained on the right side, the cash gets drained on the left side. The question is: How high is the limit of a drain on deposits? That's easy to tell. Either you look at the bank's reserve requirements or you look at their capital and reserves.

Let's analyze the bank reserve requirements first. This is the amount of cash reserves a bank needs to have as compared to the deposits and notes. Cyprus currently has a 7.5 billion euro contribution of deposits and loans. And the reserve requirements were only 2 billion euro (see Chart 1), then deposit flight is higher than reserve requirements. That means Cypriot banks will most likely not have any cash left over as a reserve unless they can sell some assets for cash. Which means there is a probability that they are becoming illiquid. We all know what happens during a liquidity crisis as we witnessed the credit freeze in 2008.

The same can be said for the other countries below. For example, Belgium has a reserve requirement of 1% and bank assets of 1.2 trillion euro. If we get a flight out of the Belgian banks of more than 10 billion euro (or a tax levy of more than 10 billion euro), then Belgium has more chance of becoming illiquid unless they can convert some assets into cash.

Chart 1: Reserve Requirements

To be more accurate (because a bank can actually have more capital and reserves than the reserve requirement), we look at the capital and reserves of the banks. This is given in the following table of statistics. The capital and reserves are given in the last column (Table 1):

(click to enlarge)

Table 1: Bank Statistics

If we look at the ratio of capital and reserves to the amount of deposits for each country, we can easily see which country is the soundest (left side) and which countries are less liquid (right side). If a bank run were to occur for the countries on the right side, banks of those countries could face a liquidity problem.

(click to enlarge)

Chart 2: Capital and Reserves to Deposit Ratio


If you as an investor have investments in a bank in any of the countries with a low capital-to-deposit ratio (right side of Chart 2), you might want to consider diversifying out of this investment. If we see a bank deposit flight in these countries, just like what happened in Cyprus, these banks could see liquidity problems. As a result, they will need to sell some of their assets to boost their cash reserves. And that might have a significant impact on the value of the assets of these banks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: A Short Analysis Of Capital Reserves Of European Banks