JANUARY 2015 / NO. 1
TAGS: BANKS, GREY SWANS, EU, ECB, SWISS, US, CREDIT AGRICOLE

The leverage ratio of banks is far too low

“If I had asked people what they wanted, they would have said faster horses”, Henry Ford
“The best way to predict the future is to invent it”, Steve Jobs (2011)
We have reported on the continuous threats to banks, and have identified that these are not Black, but Grey Swans. Black swans are large-scale unpredictable and irregular events of massive consequence for which we hardly can prepare ourselves. Grey Swans, on the other hand, are events which have a very high impact, but one for which organizations are able to prepare themselves. Banking is such a huge Grey Swan. Why is this?

The Leverage Ratio?

The Leverage Ratio for Banks, or their Equity on Total Assets must be at least 3%.
The EU/ECB wants to increase the Leverage Ratio to 4%. And Swiss and US banks already are close to a Leverage Ratio of 9-10%. However, many banks in Europe still have a value of only 2%. Imagine that you are an entrepreneur and you want to raise capital or get a loan from a bank: those same banks will, as a precondition, ask you for a Leverage Ratio of at least 40-50%.
Where is the new Grey Swan? By January 2014 the authorities gave banks a green light that the Leverage Ratio no longer applies to Total Assets, but on total assets whereby the left side and the right side of the balance sheet of similar assets are cleaned-up. So, the Leverage Ratio is related to lower total assets to get higher percentages of the Leverage Ratios. This implies that the Leverage Ratio is related not to gross total assets, but to net total assets. This reduces the financial liabilities of banks by around 60%! According to our research this is a huge Grey Swan having a very high potential negative impact.

New funding to save banks?

Closely related to this is new special funding of some € 55 billion created by the ECB; by 2026, banks in deep trouble could perhaps rely on this. Take into account that the total assets of all banks in the EU is € 30,000 billion, and bear in mind, for example, the largest bank in France, Credit Agricole, has total assets of € 2,000 billion. We might conclude that during a second potential financial crisis (the first was from 2008-2013), banks, politicians and the EU/ECB will once again rely heavily on European taxpayers who will, again, be called upon to solve the next financial crisis. Business as usual!

What is the new challenge?

This Grey Swan will be of considerable impact and there will certainly be more Grey Swans. The challenge for management today is to identify all those Grey Swans which may have a future impact on the organization. It is better be prepared than to be surprised. This reminds us of Peter Drucker who stated over 50 years ago: “There are companies that make things happen, there are companies that watch things happen and there are companies that wonder what happened?”
“We need in Brussels more courage, more leadership. However, by showing more courage and leadership they are not re-elected”, Paul Polman, CEO of Unilever
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