As readers know, I have been skeptical of the way that eurozone bank capital ratios are calculated. This is because: (1) risk-weighted assets are small relative to book assets, which is dubious; (2) substantial amounts of bond portfolios are not marked to market; and (3) eurozone government bonds are assigned a low risk-weight.
In other words, eurozone regulatory capital ratios lack useful information content for uninsured depositors and other "investors". This leads me to look at capital ratios which I can calculate myself using public data. One of these ratios is the classic leverage ratio: common equity to book assets, artifacts of financial accounting. I would prefer to use tangible common equity as the numerator, but I will settle, for today's purposes, for just common equity.
I have made a list of the major banks of the major countries, and went onto their websites to get the most recent published balance sheet data. This took more effort than it should have. Not all IR websites are equally useful. I don't want to point fingers but for some, the most recent balance sheet was elusive; for others it was offered but wouldn't load (Mitsubishi and MPS, for example). Not to point fingers, but I distrust banks that seek to hide their financial data.
I have, using my hand-held calculator, compiled a schedule of the book leverage ratios of a few of the world's major banks. Below is my schedule of leverage ratios, from lowest to highest, as I calculated them using what I could find on their websites. Most of the data is 12/31, the rest is 9/30.
Banca MPS 3.0%
Deutsche Pfandbrief: 3.4%
Does this data have any information content? I would say: at least as much as the official regulatory capital ratios. Both are distorted, and neither is reliable. But I think that anything less than a 10% book equity-to-assets ratio is too low. Call me old-fashioned, but there is no substitute for common equity to absorb the unexpected losses from such "risk-free" assets as super-senior subprime CDOs and Club Med government bonds.
Is a eurozone bank really solvent if it would be completely wiped out by an Italian default? Shouldn't such an exposure be either (A) subject to MTM; or (B) subject to impairment? Well guess what, in Euroland, Italian government bonds are worth their face value and have a zero risk-weight. If I'm wrong about this, someone please tell me. If I'm right, then eurozone bank capital ratios have no information content.
One of the most important lessons of the last five years is that there are no risk-free asset classes. Every asset class besides deposits at the central bank have proven risky. If one looks at the banks with the lowest capital ratios, one will see that most of them have had very large write-offs, which suggests that their asset portfolios contain substantial risk. Take Deutsche Pfandbrief Bank: it lost EUR 1.5B in 2009. Is EUR 3.3 the right amount of capital for such a bank? Or Bankia: it lost EUR 21B in 2011-12. Is EUR 10B an adequate capital level for a bank which has written off EUR 21B over a two-year period? I don't think so.
I think that the entire eurozone banking system is materially undercapitalized, and I think that games are being played to disguise that fact. This is why I don't think that the eurozone should introduce "depositor discipline" at a time when most of its banks are either undercapitalized or insolvent.
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. I have no business relationship with any company whose stock is mentioned in this article.