Complete Property Market Updates of Singapore

April 27, 2008

Cutback in bank lending puts US economy at risk

Filed under: General — Propertymarketupdates @ 12:29 am

Minimum capital ratio requirements limit banks’ ability to dish out loans

Bank holding companies including Citigroup and Bank of America have the thinnest safety cushion against losses in seven years.

The margin may erode further in coming weeks. Credit ratings on US$704 billion of bonds have been cut this year following the collapse of the US housing market.

Sheila Bair, chairman of the Federal Deposit Insurance Corp, said last week that the downgrades may compromise bank capital ratios enough that some of the largest institutions will no longer be considered well capitalised.

Falling below a regulatory benchmark that is intended to maintain a minimum level of capital to protect depositors against losses would subject banks to more scrutiny from regulators than they have ever experienced.

‘This is a nightmare for the country,’ said William Isaac, who was chairman of the FDIC from 1981 to 1985.

Banks will ‘raise what capital they can, then they’ll slow down their growth and stop lending, and what should be a mild recession becomes a much more serious one.’

The biggest danger to the economy is that to preserve their ratios, banks will cut off the flow of credit, causing a decline in loans to companies and consumers.

Banks have already raised US$136 billion in capital and cut dividends. More stock sales and payout reductions are likely to follow, says analyst Meredith Whitney at Oppenheimer & Co.

The credit crunch has already cost the world’s biggest financial companies about US$232 billion.

‘Banks have to maintain their ratios,’ said Dennis Santiago, chief executive officer of Institutional Risk Analytics, a Californian research firm that monitors banking statistics. ‘This is an institutional panic. At what point will consumers feel the panic? I don’t know.’

The banks need to shore up the ratio of the value of their common stock, preferred shares, retained earnings and loss reserves to the total of risk-adjusted assets, which are affected by credit ratings.

To be considered a ‘well capitalised bank’ by US regulators, an institution cannot have more than 10 times its capital in risk-weighted assets. More than 99 per cent of American banks qualify as well capitalised.

As a group, regulated banks had a total risk-based capital ratio of 12.79 per cent at the end of last year. The figure was the lowest since 2000, before the last US recession.

The holding companies for Citigroup, Bank of America and Wells Fargo have the lowest ratios in at least the five years that the Federal Reserve has been tracking the data.

Citigroup had stock, retained earnings and preferred shares in 2007 equal to 10.7 per cent of its risk- weighted assets. That’s down from 12.02 per cent in 2005.

Wells Fargo was at 10.68 per cent, down from 11.76 per cent, and Bank of America, 11.02 per cent, down from 11.08.

By contrast, the average ratio for the nation’s 66 biggest bank-holding companies was 11.63 per cent. JPMorgan Chase had a ratio of 12.57 per cent, up from 12.04 per cent.

Fed chairman Ben Bernanke described bank capital requirements in congressional testimony April 2 as ‘the nub of the problem’ and said US institutions had ‘hunkered down’ and were lending less.

‘The important thing to remember about capital ratios is that they are minimums,’ said Ralph Sharpe, a lawyer at Venable LLP in Washington, who was director of the Office of the Comptroller of the Currency’s enforcement and compliance division from 1984 to 1994.

‘In good times everybody looks good, but when the tide goes out, you see who is not wearing their bathing suit.’ – Bloomberg

Source : Business Times – 9 Apr 2008

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