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Capital: how much is enough?

Should banks be raising more money? But of course!, you cry. We’re in a credit crunch, don’t you know. Rights issues all round.

Barclays was on Thursday punished for opting, broadly, to wait and see. No denial by management that a capital raising may in fact be necessary. But no immediate need for one either. In the current climate, shareholders perhaps take comfort that banks are doing something rather than nothing, even if that something results in the permanent dilution of their investment. Moody’s also was displeased, downgrading the bank’s financial strength rating and changing its outlook on Barclays’ debt to negative.

There are those who claim that Barclays is in denial. It has been less aggressive in writing down its exposure on, say, leveraged loans than rivals. With an equity Tier 1 of about 5 per cent, it is now among the most scantly capitalised banks in Europe. It is, the argument runs, just delaying the inevitable.

The counterpoint is that banks should tap shareholders for funds because they need to, not just because they can. And the fact that Barclays has opted to ride it out for the time being suggests that there hasn’t yet been a regulatory edict from on high that banks must seek out a plus-sized Tier 1 ratio.

Nils Pratley in the Guardian is pleased:

…the bank is surely correct on the basic point. Rights issues dilute returns for shareholders permanently. They are an expensive way to raise capital. In general, managements ought to regard them as a sign of failure. They should be treated as a last resort….

…at the risk of being proved dreadfully wrong in six months’ time, let’s stick our neck out: Varley and Diamond deserve praise for resisting the soft option of fleecing their shareholders.

1249.jpgCreditSights, with table right, notes that on simultaneous conference calls on Thursday, Credit Agricole and Barclays sounded like they were making their respective capital decisions in different eras.

The French bank thinks that in the new world regulators will require lenders to have higher capital ratios than in the past, hinting that the signals it has been given are that 8 per cent may well emerge as a minimum for overall Tier 1, with 6 per cent for core (excluding prefs and other hybrids)

Barclays didn’t get the memo. One of them has misjudged the mood.

Or alternatively, the mood itself is misjudged.

Bernanke has urged US banks to continue raising capital, saying this could pave the way for improved economic conditions.

Bill Blain at KNG Securities provides the counter-argument:

NO NO NO! There is only one thing worse than a bank that is short of capital - and that’s one that has too much! Capital strapped banks are careful and cautious, and look after their shareholders. Banks with too much capital do silly things like lend to people who can’t possibly pay back or they go and buy Dutch banks for absolutely no perceivably good reason.

Short-term, banks have to continue the deleverage process, and yes they do need to raise capital selectively. And those guilty of hubris - come on down Fred, Chuck, Stan, Marcel, and Jimmy - pay the price. Some banks will/have be forced into rights issues. But to make a virtue of raising capital is not a good thing - it’s bad bad bad! Running efficient banks well on the right amount of capital is the path of virtue. Running fat lazy banks on the amount of capital a regulator tells to you to have is not.

Related links
Bernanke presses US banks - FT.com
Barclays silence - Lex

This entry was posted by Helen Thomas on Friday, May 16th, 2008 at 10:22 and is filed under Capital markets. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.

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Comments

  1. May 18   4:35 Posted by Anonymous [report]

    “Raising capital” is a euphemism for “feeding Wall Streets addiction to gamble with other people’s money”. Ben Bernanke now is engaged in the kind of reckless financial engineering that created this banking crisis. Rather than being the sober and prudent central banker, Ben has concocted new, more powerful money-laundering schemes (TSLF, TAF, PDCF) to “provide liquidity” a.k.a. bailing out reckless “bankers” (a.k.a. 30:1 leveraged gamblers with other people’s money).

    Now that the Fed has supplied the Ponzi scheme with a fresh infusion of other people’s money (Fed’s T-bills), everything is rosy and Wall Street has cherry blossoms in springtime bloom.

    Ben is creating Moral Hazard on an unprecedented scale. Volcker is being as polite and circumspect as he can in order not to shout “fire” in the Fed theater. But Volcker’s concern is clear. A few weeks ago Volcker said that the Fed was at “the very edge” of its legal authority, “transcending in the process certain long-embedded central banking principles and practices”. Volcker’s alarm is sufficient cause for Congress and federal prosecutors to investigate Ben and the Fed for breaking the law, that is, criminal violations. Yes, it is that serious.

  2. May 17   7:48 Posted by A DOWNING [report]

    Right issues should be good news for bondholders.

  3. May 16   15:57 Posted by BovBear [report]

    Makes no mention of political pressure to recapitalise to allow a slower deleveraging process and therefore less of a shock to the wider economy

  4. May 16   14:12 Posted by S Wathen [report]

    No mention in this note of the consequences of the last Barclays rights issue in the late 80s when they took more money than they needed, because it was available, and disaster followed - hats off to the management and board for their current approach.

  5. May 16   13:49 Posted by Monkey [report]

    IFRS provisioning makes sense given the propensity of big bath provisions that companies used to make in order to smooth earnings and hide earnings volatility.

  6. May 16   13:19 Posted by D Russell [report]

    Whilst formerly good banking practice, unfortunately in the world of IFRS under which all the banks are now reporting, general provisions against loan losses are not permitted.

    See:http://www.accaglobal.com/students/publications/student_accountant/archive/2005/57/2408963 for a brief analysis.

    “IAS 39 requires an assessment at each balance sheet date as to whether there is any objective evidence that a financial asset is impaired, and whether the impairment has any impact on the estimated future cash flows of the financial asset. The company recognises any impairment loss in profit or loss, and only losses that have been incurred can be reported. Therefore, losses expected from future events are not recognised.”

  7. May 16   10:48 Posted by G Cox [report]

    This all makes sense and Barclays appears to be rational instead of raising capital in anticipation of trouble as some others have done.

    Good banking practice was to put general provision by for possible losses . Anyone know why this route has not been used ? Rights or write-off for covering non-specific anticipated losses seems to be a policy choice of devil or deep blue sea with nothing in between .

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