Tuesday, April 11, 2017

Deposit effects on bank Leverage Ratio


From American Banker magazine from a while back and out of paradigm but still relevant.


"One of the many problems with a high leverage ratio stems from the flight to safety during periods of stress, which causes bank deposits to soar. Since 2008, while the U.S. economy has struggled, deposits have risen by $2.6 trillion, often with pronounced temporary spikes that remain on a bank's balance sheet for just a few weeks. A recent example of this occurred during the politically charged debt-ceiling crisis. At that time, deposits jumped by $73 billion, according to Federal Deposit Insurance Corp. data. Deposits provide crucial funding for all banks, but as deposits surge, bank leverage ratios drop. Worse, sudden changes in deposit flow make banks' leverage ratios volatile. Most banks simply manage this volatility by staying well above the current leverage ratio requirements. That is, they are generally over-capitalized."


Checkmate.




37 comments:

st hs said...

https://www.youtube.com/watch?v=no9skxXqoQo&feature=youtu.be&a

So if that's the case does that mean Fed ending QE would reduce bank deposits(because they are used to buy treasuries) and would allow the banks to lend more? Is this what Mike was getting at in the video above?

Matt Franko said...

More or less yes but it would still be best to monitor the levels of bank reserve assets if the Fed changes the current QE policy as they have several asset classes at the Fed with perhaps differing functional relationships to bank asset composition...

So you would still want to monitor it while it happens but generally it looks like banks would be able to add higher yielding assets as Fed reduced their Factors without banks adding additional capital while stilll maintaining a constant Leverage Ratio.... which would seem favorable to the banks...

Doesn't seem like many can understand the functional relationship between Govt policy and bank deposits/reserve assets...

Here this person claims deposits are created by "the flight to safety during periods of stress, which causes bank deposits to soar."...meanwhile unbeknownst to this person the Fed is creating $3T of reserves and with it bringing down the whole banking system and causing the GFC....

They're never going to get it they just don't have the proper training....

But if they start to reduce their Factors for whatever reason their unexercised brains can conjure up, they would be generally reversing the current GFC policy and things should start to return to normal finally....

Ralph Musgrave said...

The main reason deposits have “soared” “since 2008” is simple: QE. QE has caused base money as a proportion of M2 to rise from around 10% prior to 2008 to about 30% now, far as I can see from Fed figures.

As for the idea that banks are “over-capitalized”, well a body that speaks for private banks like the American Banker Magazine would say that, wouldn’t it? Personally I go along with the idea put by Milton Friedman and at least three other Nobel laureate economists, namely that the best ratio is 100%, not the 5% or so that private banksters want.

A 100% ratio makes it plain impossible for any bank to fail. Plus to blocks an activity that everyone wants to get into, namely producing counterfeit money. Private banks effectively print money via the “loans create deposits” process. There is no need for that counterfeiting for the simple reason that the central bank and government can produce limitless amounts of money at no cost at the press of a computer keyboard button. I.e. central banks can produce whatever amount is money is needed to keep the economy at capacity, as every MMTer knows.

Matt Franko said...

Well Ralph don't discount the fact that banks have their own internal ratios they try to maintain at some target value identified by management as goals and objectives...

Those ratios might be more functionally relevant to what ends up happening than the edicts from the regulators.. as.those internal thresholds are violated EARLIER....

st hs said...

"meanwhile unbeknownst to this person the Fed is creating $3T of reserves and with it bringing down the whole banking system and causing the GFC"

So what is the link between subprime loan losses and "Fed is creating 3T reserve causing the GFC"? Or are you saying their actions exacerbated the crisis?

Matt Franko said...

They caused the liquidation of the lowest hanging fruit (sub prime) in the first place by banks to make room for the surge of deposits as capital is effectively fixed over short term periods...

Go back and look at RESBAL in September 2008 on the 10th it was like 9B then it started shooting up and Lehman locked up on the 15th Fed kept pouring it on it was up like 300B in a month and the others fell like dominoes as they had to keep liquidating other assets...

Matt Franko said...

They only had 800b total Factors in 2008, they put the rate down to 0.25% so at the bottom end, 0.25% of 800B is only $2b and that is not enough to run the Fed... they need like 10B or more...

So Fed bought more bonds to get the increase in interest income they needed and touched off the whole thing as on he other side of that transaction banks had to liquidate other assets to accommodate the new reserve assets...

Good news is that they finally may be ready to reverse at least some of this...

Michael Norman said...

Nice. Only here on MNE. Not Mosler. Not Kelton. Not Wray. Not anybody in MMT commmunity got this except for Franko right here. And it's been in my report, MMT Trader.

Michael Norman said...

MMT Trader

Matt Franko said...

And Mike the real bitch is that if they turn this thing around here, then you're gonna have all the "free markets!" idiots at AEI, Cato, Club for Growth, etc going all around saying, "see, we told you that unleashing the free markets would blah,blah, blah... " and they will be totally vindicated in the eyes of the mob....

Six said...

You guys need to dumb this down for me. Are you saying the GFC was caused by too many deposits flowing into banks? The deposits were accompanied by reserves (G spending) or were they not accompanied by reserves (loans make deposits)? Or was the GFC caused by reserves flooding into banks? I lost the plot at the beginning of this thread.

Tom Hickey said...

The GFC was "caused" by a lot of things coming together.

The chief factors were "imprudence" and "criminogenic activities," especially control fraud.

Ryan Harris said...

Nice work, Matt.

Postkey said...

“The root problem of 2008 was a failure to recognize that the highly leveraged money center banks had used derivatives not to distribute subprime mortgage risk to the broad risk bearing capacity of the market as a whole but, rather, to concentrate it in themselves.”
“The fatal misjudgment on Greenspan’s part was his belief that because the high executives at money center banks had every financial incentive to understand their derivatives books that they in fact understood their derivatives books.”

“The problem was not that the economy could not climb down from a situation of irrationally exuberant and elevated asset prices without a major recession. The problem lay in the fact that the major money center banks were using derivatives not to lay subprime mortgage risk off onto the broad risk bearing capacity of the market, but rather to concentrate it in their own highly leveraged balance sheets. The fatal misjudgment on Greenspan’s part was his belief that because the high executives at money center banks had every financial incentive to understand their derivatives books that they in fact understood their derivatives books.
As Axel Weber remarked, afterwards:
I asked the typical macro question: who are the twenty biggest suppliers of securitization products, and who are the twenty biggest buyers. I got a paper, and they were both the same set of institutions…. The industry was not aware at the time that while its treasury department was reporting that it bought all these products its credit department was reporting that it had sold off all the risk because they had securitized them… “

http://equitablegrowth.org/equitablog/misdiagnosis-of-2008-and-the-fed-inflation-targeting-was-not-the-problem-an-unwillingness-to-vaporize-asset-values-was-not-the-problem/

Tom Hickey said...

Good analysis but omits the what the derivates were derived from. That's what blew up when borrowers could not perform on their loans. Then assets values started to collapse and the financial crisis went viral taking down the economy with it.

The industry was not aware at the time that while its treasury department was reporting that it bought al

This is supposed to be the responsibility of the CEO to know what is going on in his firm.

Bill Black contends that they did know and didn't care since they would be rewarded in any event, and they were right.

The kicker is then the banks falsified the paper work to foreclose, compounding the crisis.

This was a crisis resulting from top management of the banks and behavior of cronies and minions. It was a gigantic conspiracy of mortgage brokers, appraisers, lending institutions and banks as securitizes.

As Citi honcho said, it was a game of musical chairs that CEO's had to play to stay competitive. At the end there weren't enough chairs to go around, so the government stepped in to provide them.

The losers? The public, the economy, and the banks' shareholders that paid the fines.

Six said...

Thanks Tom and Postkey, but I'm really trying to understand Matt's belief that the fed caused the GFC. I'm not doubting him or agreeing with him ... I simply don't understand his reasoning or the point he is making.

Tom Hickey said...

The Fed didn't "cause" the GFC, But Alan Greenspan in his role as chief regulation was deeply involved with his hands-off policy.

Ryan Harris said...

Here is what Boesler posted today on how the TGA draw downs get transmitted to credit and ccy.

sths said...

Blogger Tom Hickey said...
The Fed didn't "cause" the GFC, But Alan Greenspan in his role as chief regulation was deeply involved with his hands-off policy.

But if what Matt says is correct then subprime loans were liquidated on mass due to banks needing to shed assets to maintain their leverage ratio. Doesn't that sound like the catalyst, the spark that lit the fire?

Tom Hickey said...

That came well into the crisis when banks were suspected of being insolvent and the Fed bought up their dodgy assets for its own balance sheet and then formulated a per forma "stress test" to determine solvency, which anyone with a brain realize was a cover up of insolvency. The Fed then continued to mask bank insolvency by extending unlimited liquidity to support them. It was called "extend and pretend."

Of course, neither the Fed nor the banks, or the regulators will ever admit this. The banks were saved, but everyone else was hung out to dry.

Postkey said...

According to A. Kaletsky, when Northern Rock collapsed the Bank of England 'persuaded' the British government to give {reluctantly} an open-ended, but temporary, guarantee to all British financial institutions.
This stopped the bank run and stabilised the financial system.
In the US, H. Paulson did not 'take this lesson on board' and this, plus the speculation in oil prices, led to the 'credit crunch' in the US.
Capitalism 4.0. P140.
“Guarantees would have been the easiest form of intervention to present politically because they would have emphasised the true purpose of government assistance to the banking system: to prevent the savings of depositors – especially wholesale depositors such as corporations, foundations, savings institutions, and local governments. These depositors would have seen trillions of dollars in payrolls, pensions, and working capital evaporate if the banks were allowed to fail. Guarantees would have underlined the fact that the main beneficiaries of all bank rescues were not greedy bankers or shareholders but wholesale depositors whose money is not covered by retail guarantees.”
A. Kaletsky: Capitalism 4.0. P150.

Matt Franko said...

Let's say there is a plane crash.... are lawyers involved in the aftermath? Yes.... are they the ones involved to figure out what went wrong ? No... that is not what they are trained for...

Matt Franko said...

Here reader Derek sent this to me, looks like they are on to this problem at the BOE from Jan this year post Brexit:

http://www.bankofengland.co.uk/pra/Documents/publications/reports/prastatement0816.pdf

"The FPC noted it is making this improvement to the design of the leverage ratio in the United Kingdom now, given the actions taken to maintain monetary and financial stability since the referendum on the United Kingdom’s membership of the European Union. It recognises that, absent offsetting the impact of this change, excluding current central bank reserves from the exposure measure – the denominator of the leverage ratio – mechanically reduces the nominal amount of capital required to meet the leverage ratio standard, other things equal. This is not the FPC’s intention. It therefore intends to recalibrate the UK leverage ratio standard to offset this impact."

Matt Franko said...

Tom, remember Taleb's observation:

"Mathematicians think in axioms, applied mathematicians in limits, Probalists think in inequalities, philosophers in concepts, jurists in costructs..."

Black is a trained jurist, is this quantifiable regulated system best analyzed via constructs? I don't think so...

Within Talebs context here I am probably using limits and/or inequalities ... based on t he way I have been trained to think....

Matt Franko said...

"But Alan Greenspan"

Trained clarinet player...

Matt Franko said...

Look at this diagram here it's an unprecedented time domain response:


https://mikenormaneconomics.blogspot.com/2017/04/interesting-chart.html

Question is does building the TGA and thus removing bank reserve assets by 400b over a period of 11 months and then flooding them back in 1 month cause problematic volatility in a regulatory parameter for the banking system?

Based on this guys article complaining about a 73b surge I would say yes...

Look at a NIA GDP target growth of 3% on what an 18T us economy now? 3% of 18t is only like 500b ... so you have these people screwing around with 400b of bank assets so how can big ticket producers get an additional 500b of product sold (which is seemingly what everybody is gunning for...) when other govt policy is removing 80% of bank current ability to do that?

400b is a substantial magnitude of annual volatility in this parameter even in an NIA $18T economy...

Six said...

Color me ... unconvinced.

Six said...

Stability (less leverage) leads to instability (adding on more and riskier leverage)? Minsky?

Matt Franko said...

Well the BOE is....

Matt Franko said...

Stability is a flow and leverage is a stock

Tom Hickey said...

Matt, that I am saying is that in such situations there is a constellation of causal factors operative and no single factor can be identified as "the" cause. A lot of things had to come together to result in the GFC, the Great Depressions, etc. There can also be catalysts that are not causal factors but rather attendant conditions.

For example, derivatives did not cause the GFC, but the GFC would not have happened without derivatives that greatly increased systemic risk. The problem was the underlying assets failed resulting in the implosion of the derivates based on them.

Then the question become why the underlying assets failed, and that explanation has to include banks' imprudence as well as violation of laws and regulations. The GFC would not have gotten off the ground otherwise.

When banks make loans, they create deposits and their leverage ratio is affected. Banks that are well run have no problem adding capital to maintain the ratio, however.

Tom Hickey said...

Let's say there is a plane crash.... are lawyers involved in the aftermath? Yes.... are they the ones involved to figure out what went wrong ? No... that is not what they are trained for...

You are making my point, Matt. BB was not "a lawyer," but an experienced forensic investigator who has a first-class reputation in examining bank crashed from the legal (criminal) pov. His investigations in the S&L crisis result in a thousand successful prosecutions. Holder took that off the table.

Tom Hickey said...

Seems to me that leverage is the ratio of the stock of liabilities (debt) to equity (capital), while stability is rational of the the stock of high risk assets to low risk. These stocks change wrt flows, so that both the amount of leverage and the "quality" of leverage changes.

Tendency over time in a financial cycle is for both leverage to increase and stability as the quality of leverage to decrease.

Tom Hickey said...

American Banker writes:

A recent example of this occurred during the politically charged debt-ceiling crisis. At that time, deposits jumped by $73 billion, according to Federal Deposit Insurance Corp. data. Deposits provide crucial funding for all banks, but as deposits surge, bank leverage ratios drop.

I don't understand how "bank deposits soar" unless people deposit cash or banks create new deposits by extending new loans, or government spends or lends. The aggregate deposit level in the banks is just transferred among banks. So if one banks deposits go up from deposits not made in cash and don't comfort new lending in the banking system or from government spending/lending, where does it come from?

I don't see the mechanism here.

Ryan Harris said...
This comment has been removed by the author.
Tom Hickey said...

Goldman

http://www.zerohedge.com/news/2017-04-13/sorry-goldman-loan-collapse-real

Matthew Franko said...

The article is out of paradigm no doubt.... but when the Treasury uses the "extraordinary measures" at the debt ceiling, they somehow are able to withdraw from the TGA in excess of what is a fixed amount of UST issued (they borrow from Fed. Emplyee govt bond fund or something...it has like iirc like a 200B max....) ... so what ends up happening in the banking system is bank assets increase with no ability for govt to do a "reserve drain" aka UST securities issuance... so reserve assets accumulate on bank balance sheets short term and 'crowd out' other bank assets like loans/leases etc... its bearish...

Mike is tracking this, the shtf on March 15th same day we hit the 'debt ceiling'.... BAD!