genX

18 Jul 2013, 09:52 PM

True, but if the expected loss for a particular type of asset is not particularly onerous, then Tier 1 rarely becomes a constraint. Margin compression due to perceived credit risk would constrain a banks lending long before Tier 1 capital requirements did. Tier 1 capital requirements are based on expected losses, and as such don't change much until greater losses are realised. Credit spreads however change much faster, a 50bp margin compression would put the brakes on most Australian banks. 100bps and stick a fork in it.

peter fraser

18 Jul 2013, 10:02 PM

well banks can raise shareholder equity very quickly in the market,

Quote:

 

but it nevertheless becomes a cost for them as cash, bonds and other acceptable liquid assets don't earn much income which pushes down ROI which must affect dividends.

genX

18 Jul 2013, 10:07 PM

Only if they are profitable. Generally the market doesn't provide buy equity in unprofitable companies (well, before the new normal anyway). If the bank's lending margins compress such that they are unprofitable, it becomes very difficult to raise equity, because the equity holder would effectively be assuming the credit risk.

Sure, holding a lot of Tier 1 assets will push down ROE, but not as much as losing money on every loan you make.

Pig Iron

16 Jul 2013, 08:02 PM

Timo you told me housing would crash over 12 months ago. Now it is up 6%.
Admit your failure and move on.

Timo

21 Jul 2013, 08:12 PM

12 months ago?

6%, dream on negative equity queen. Loving the mining slump?

Pig Iron

21 Jul 2013, 10:26 PM

i know i can hardly believe you have gotten it so wrong for so long as well, so i forgive your shock.

http://www.rpdata.com/research/back_series.html

it's all there for you timo. 6% yoy. WA unemployment has dropped, mortage holders have more of a buffer than ever. inspite of this so called collapse in mining that you keep pointing to.

and the best part, is your rent is UP UP UP

genX

18 Jul 2013, 07:08 PM

I am also 99.9% sure that is the case. If Mike has information to the contrary I would be interested to hear it.



Not by a long shot. Yossarian would probably be the best educated. b_b also, although I think there are some gaps in b_b's understanding.


Maybe.


There is no $400k, there is only promissory note.

It's not quite true. Deposits are one type of loan the bank uses to fund lending. They also borrow from other banks and from the central bank. The difference between funds on deposit and loans out is the amount the bank needs to borrow from other sources.

No, deposits are not reserves. Deposits are loans , i.e. liabilities. Reserves are composed of assets: usually debt instruments such as deposits at the central bank, sovereign bonds or other credit grade bonds, but sometimes gold.

The bank does that anyway. Deposits are on call. They are a type of overnight lending. While they don't fluctuate a lot, they do fluctuate every day. At the end of the day the banks net off deposits and withdrawals and borrow any shortfall.


They borrow the money from whoever will lend it to them at the lowest rate. The RBA is generally considered to be a lender of last resort if a bank cannot borrow from any other lender.

Yes they do. The RBA is basically a liquidity facility to smooth over any problems with interbank lending i.e. it is a lender of last resort.


The reason banks don't borrow all their money from the RBA is due to a mixture of collateral requirements, credit spreads, tenor matching and so on.

All money is borrowed, whether the source is a depositor, a bank,or a central bank is really a function of the term structure, the spread and the collateral requirements. Deposits (traditionally) have the advantage of the highest spread and the lowest collateral requirements (i.e. none), but the disadvantage of the shortest maturity (i.e. one business day for a standard savings account). Generally there is a term premium for all types of lending, although having an inverted yield curve for years implies there may no longer be so.



In your example, CBA borrows 20k from the depositor and 380k from NAB. There is no reserve in that example.


Your example is not correct. The reserve requirements for lending is that the bank needs to hold the expected shortfall of any type of lending multiplied by a risk-weighting for that asset. If the expected shortfall for housing is: 1.7% default rate with a 90% expected recovery rate i.e. expected loss of 0.17%, and the risk weighting is say, 2.3, then the reserve requirement for mortgage lending would be 2.3X0.17=0.391% of the notional outstanding. If the default rate is 2.5% and the expected recovery rate is 80%, then the bank would need to hold 1.15% of notional outstanding as a reserve.


I think the confusion arises because people believe (as I once did) that money and loans are two different things, but they are not.

Every instrument in the modern banking/monetary system is a promissory note. That includes cash, deposits, cheques, demand drafts, letters of credit, bills,bonds, loans, swaps and anything else that meets the definition of a contract or promise to pay the bearer on presentation of the note. Once upon a time, a promissory note was a promise to deliver some precious metal such as silver or gold. That is, a bank note for 1 pound sterling was a promissory note for a pound of sterling silver. These days, the issuer of the note only promises to deliver another note (one of the strange infinite loops of modern fiat currency).

NAB doesn't create anything in the scenario above. CBA creates a promissory note, which NAB accepts. The holder of the note considers the note to be an asset (because it is a promise to pay) and the issuer of the note considers it to be a liability (because they have promised to pay). Money and promissory notes are synonymous. When I say all money is issued as debt, it is semantic convenience. It would be more accurate to say, all debt is issued as debt, or all forms of modern money are promissory notes (i.e. debt). If NAB does not want to hold CBA's note, and no other bank wants to hold CBA's note, then the RBA can either hold the note, or print some 'money' to lend to CBA so they can pay the bank where the note was presented.

When I came to understand the modern banking system, my first question was: "What prevents banks from creating an infinite number of loans and funding them by borrowing from the central bank?". The answer is fairly complex, but at it's simplest, most lending is secured. That is, every liability has a matching asset. So in the case of mortgage lending, the amount the banks can lend is a function of the housing stock currently for sale. That's one part. The second part has to do with lending spreads. Typically, the more you lend, the greater the chance you will lend to people who don't repay their loans. i.e. the quality of your assets decreases, and when that happens, the other lenders who fund your lending business will raise their lending rates to you. That is, your margin compresses. Lending is only profitable when the spread is greater than your operating costs plus your expected shortfall (i.e. the default rate and the recovery rate). If your margin compresses to the point where it is no longer profitable to lend, you stop.

One way that US banks dealt with this problem in the lending spree from roughly 2000-2006 is something called rehypothecation, which is really like re-insurance. You sell securities which are derivatives of the original loans, which has the effect of spreading the risk, and making lower margin lending more profitable (i.e. the losses and the profits are shared). As we saw in the GFC, this had the effect of transforming credit risk into systemic risk, because the same institutions that were selling these securities were also buying them, thus concentrating risk rather than distributing it.

Strindberg

18 Jul 2013, 07:44 PM

Bank lending in Australia is simply not constrained by deposits. Saying that Australia has a fractional reserve system with the fractional reserve ratio at zero deceptively suggests that such a system still operates. It doesn't.

Bank lending in Australia is constrained by specific rules based on a bank's risk weighted assets (ie mainly its loans) and not based on its deposits.

Australian banks deal with each other through their ESAs (Exchange Settlement Accounts) which are the banks' deposits with the RBA. After the day's cheques and whatnot have been cleared the banks calculate what they owe or are owed between each other and their ESAs are adjusted accordingly.

Massive

17 Jul 2013, 12:29 AM

or - apparently - be the dude whose business dries up in an economic downturn who was using his house as equity ...

Quote:

 

Moody's takes tougher line on debt

September 6, 2013
Clancy Yeates

Moody's Investors Service has downgraded its credit ratings for subordinated debt issued by Australia's big banks, as regulators toughen their stance on any future bailouts.

In a move that affects lenders including Commonwealth Bank, Westpac, ANZ, NAB and Macquarie, the credit agency made a two-notch cut to its ratings for subordinated debt, which ranks after other types of debt if a company fails. The decision does not affect the banks' overall credit ratings, which are critical for their ability to raise funds on global markets.

The change comes as regulators try to protect the financial system against moral hazard - where lenders and their investors take excessive risks in the knowledge they will be bailed out by government in the event of a collapse.

During the global financial crisis, governments tended to support struggling banks by injecting equity, which shielded bondholders from wearing losses.

But Moody's analyst Patrick Winsbury said there was a growing international trend of ''selectively imposing losses'' on investors in more junior types of debt.

''We recognise that Australian bank supervisors have, in the past, acted in a manner to support all bank creditors,'' he said. ''However, the global financial crisis has demonstrated that support can be provided selectively and bank recapitalisation costs shared with subordinated creditors without triggering any contagion, as was previously feared.''

At the height of the 2008 crisis, Australian banks and their creditors benefited from government guarantees of deposits and wholesale funding.

Recent rescue efforts in Europe, however, have inflicted losses on bondholders.

Read more: http://www.smh.com.au/business/moodys-takes-tougher-line-on-debt-20130905-2t823.html