Why The Global Bankster Risk Is Not Calculated, But Incalculable….

…and why RBS is a basket-case

By John Ward: US Fed Reserve vice chairman Tom Hoenig (below) is still worried about taxpayers’ exposure to the banks’ risky positions, he told Fortune Magazine recently. Poor old Tom is behind the music here, for shurely any foole know that it is the creditors, not the taxpayers, who will cough up this time. On the other hand, maybe Tom has spotted that they’re the same people, and simply can’t be bothered to go along with the robotic Newspeak.

Some tentative steps have been taken to make banks safer since 2008 – increasing the leverage ratio from 3% to 5% for bank holding companies, and 6% for banks – but these are slim streams of urine to fire at the approaching tidal wave…and even those have been fought tooth and nail by the frontal lobe tendency. Hoenig points out with refreshing honesty that the difference between collateralised debt obligations that got banks into a pickle during the 2008 crisis, and the collateralised loan obligations they now have on their books, are little more than cosmetic. Similarly, the book ‘value’ of derivatives is more silly that it was before the Crunch. And of course, when it comes to the loan portfolio, every last one of the beggars is leveraged like a Geithner bazooka gone nuclear.

One of the problems is that banks can show what look like healthy asset-to-capital ratios, but by no means all those assets are loans…and not all loans are equally secure. The best way to look at this is the capital (or deposits for some mutuals) to loans ratio… usually expressed as a capital adequacy level of equity that must be held as a percentage of risk weighted assets. Goldman Sachs, for example, has a 14.2% capital to risk level. Put another way, it would take just one seventh of Goldman’s loans to go bad, and they’d be wiped out.

Across Asia, the following levels leap out from the columns: 15.8%, 15.3%, 13.5%, 12.7%, 14.2%, 15.7%. So pretty much of a muchness – ie, in the current climate, nowhere near enough. In China itself, the central bank stands at 12.04%, ICBC is at 14%.

In banking circles, these % ratios are all regarded as “more than enough” to cope. But that’s bollocks. Not that I’m suggesting they should be the marker, but Islamic Bank ratios range from 43-65% CTR. It could be because the penalty for Islamic bankers going bust is stoning or something, but the truth is, it’s a culturo-religious thing: it is a serious sin to profiteer from another, and socially a massive disgrace to leave investors – sorry, creditors – in the lurch. Cultural or not, Islamics don’t set those levels for fun: they do it based on calculated risk.

The trouble with secular banking is not calculated risk – it’s incalculable risk. And the biggest single reason remains exactly the same: derivative commitments.

In that general context, I’m staggered as to why people still wonder why I guffaw so much about an RBS “returning to health”. Here’s why. In the latest available TWST analysis of Royal Bank of Scotland, the following can be read (my emphases):

‘A key part of the restructuring programme announced in February 2009 was to run down and sell the RBS Group’s non-core assets and businesses with a continued review of the RBS Group’s portfolio to identify further disposals of certain non-core assets and businesses. Assets identified for this purpose and allocated to the RBS Group’s Non-Core division totalled £258 billion, excluding derivatives, at 31 December 2008. By 31 December 2013, this total had reduced to £28.0 billion (31 December 2012 – £57.4 billion), excluding derivatives, as further progress was made in business disposals and portfolio sales during the course of 2013′.

The Osborne strategy is to dump all RBS’s investment side and return it to retail status – hence the need to get rid of Hester, who remained obdurate on the need to retain a strong investment side. But either way, the same basic fact is inescapable: everyone’s ignoring the elephant in the corner with body odour issues. Wall Street insists that all derivatives are netted, which is an impossible thing for anyone to know. And you will look in vain for any estimate of derivatives exposure in the RBS Annual Report.

What the TWST report will give you, however, is a horrific list of all the things that make shares in RBS a high-risk investment…and the sting is in the highlighted tail:

‘…. loss resulting from inadequate or failed internal processes, people and systems, or from external events. The RBS Group has complex and geographically diverse operations and operational risk and losses can result from internal and external fraud, errors by employees or third parties, failure to document transactions properly or to obtain proper authorisation, failure to comply with applicable regulatory requirements and conduct of business rules (including those arising out of anti-bribery, anti-money laundering and anti-terrorism legislation….In addition, certain competitors may have stronger and more efficient operations, including better IT systems allowing them to implement innovative technologies for delivering services to their customers, and may have access to lower cost funding and/or be able to attract deposits on more favourable terms than the RBS Group…The RBS Group has significant exposure to a weakening of the nascent economic recovery in Europe…The RBS Group has significant exposure to private sector and public sector customers and counterparties in the eurozone (at 31 December 2013 principally Ireland (£39.8 billion), Germany (£31.1 billion), The Netherlands (£25.9 billion), France (£23.8 billion), Spain (£11.2 billion) and Italy (£7.1 billion)…The November 2013 [Basel stress test] update placed the RBS Group in the second from bottom bucket, subjecting it to more intensive oversight and supervision and requiring to have additional loss absorption capacity of 1.5% in CET1 to be phased in from the beginning of 2016.’

So that’s all OK, then. Nothing to see here, because, um, we’ve hidden it. Move along now please.

Yesterday I posted about the fear surrounding Credit Suisse’s guilty plea – how the authorities openly admit that they had to weigh CS’s obvious, profound and longstanding guilt against the ramifications of its potential collapse in a Lehman moment. In 2007, I blogged at length about Lehman’s overdependence on high-risk investment, one reward for which was the threat of a writ from its lawyers. It’s CTR ratio then was 14.8%. It went under within a year.

For five years or more now, we have all been using the dominoes analogy. Today, it’s too obvious and nowhere near urgent enough as a warning. The globally interlinked property balsa-wood, banking risk pack of cards, business stimulation straw, sovereign bond paper and leaking derivative petrol can are all in one small room. The situation is so dangerous, there isn’t even room for the elephant. One spark and that’ll be it.

Source