Bank Valuation. Which bank? Part 2. Banks take your money (you the depositors) to make profit for their shareholders

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VALUATON. Which bank?  Part 2. Banks take your money (you the depositors) to make profit for their shareholders

In 2008, the US economy and the stockmarket were on a high. Money was flowing freely and the Wolves of Wall Street were getting more on a high due to excessive money, drugs and sex. Meanwhile US population was borrowing and investing in risky products. Banks cowboys became greedy and wanted to follow the other cowboys on Wall Street. Regulators? Where were they? You may ask. The big bang occurred when Lehman Bros fell due to reckless borrowing appetite and banks taking more risks.

Could have the collapse been avoided? It has to be recognised that the market and its participants lacked transparency at the GFC.

Following the crisis in the US, the word “derivatives” became a dirty word. Why? Because many banks, especially the big ones, were taking a high degree in risky derivative trading and that may have been the catalyst which caused the major problem.

Banks operate in their own world of hide and seek. Since the GFC, massive efforts have been made to clean up the way banks operated and put regulations in place aimed at restoring confidence in the financial system.

Another global financial crisis may be on the way if the lesson from 2008 is not learnt. The IMF has suggested that Australian banks need to increase their capital. This was not received favourably by the banks. Why?

Capital requirements is no more than restrictions on the funding mix by the banks. Higher capital requirements forces the banks to raise more equity from the shareholders and reduce their reliance mainly from depositors and those who lend the banks funds. You see banks’ funding mix can be from equity, deposits and borrowing. Yes, banks borrow on the international markets.

Questions must be raised about what the bank does currently and what the regulators ask the banks to do. It is an important issue when it comes to WHO bears the risk in banks’ operations. To service their lending and investments, banks need to receive funds from various sources.

Banks’ current leverage (contrary to what the regulators are asking) is based on higher funding intake from depositors and lenders and lower funding from shareholders. This pushes the risk that shareholders take as higher and less risk for depositors. The return for each will be commensurate with the risk they each take.

The regulators are asking banks to raise their capital requirements. This is because shareholders will then bear more of the risk associated with bank activities, with their equity providing a buffer to protect depositors and debt holders from any possible losses. This of course is an advantage for taxpayers as governments take the brunt of any losses since they guarantee depositors.

Banks don’t like it. Why? Because now the cost to fund their operation from depositors is low (due to low interest paid). So they take money from depositors and invest it in higher risk sphere and pay higher return to shareholders.

So question: Why the return on depositors is low when it is their money that is being used to pay higher return to shareholders. Because depositors are guaranteed by the taxpayers that their funds are protected.

Financial reforms didn’t work. Banks are still getting bigger and fatter. Banks continue to trade derivatives in many of the same ways they did before the crash, but on a larger scale.

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