The $2 leverage into real-estate makes sense. Lend to real-estate at any opportunity. Apparently over the last few years in Ausi banks have also encouraged interest only mortgages.
Printable View
It makes sense in a real estate market that is going up or liable to go up. Under Basel 2 the RWA would not change if the real estate market had a downturn. But under Basel 3, the RWA goes up if property prices fall. That means the bank needs more capital to support the same loan. At least that is how I read it.
SNOOPY
Reading about credit risk, it strikes me that there are so many 'credit risk' buzz abbreviations, that it is almost impossible to read up on the subject. So I have decided to list some of these abbreviations for future reference.
Most of these are those definitions from the following book.
"Final Basel III Modelling: Implementation, Impact and Implications by Ioannis Akkizidis and Lampros Kalyvas"
CCB = Capital Conservation Buffer
CCR = Counterparty Credit Risk
CVA = Credit Valuation Adjustment
VaR = Value at Risk
DR = Default Rates
EAD= Exposure at Default
ECRA = External Credit Rating Assessment (One alternative approach for calculating RWA)
EL = Expected Loss
UL = Unexpected Loss
ES = Expected Shortfall
FRTB = Fundamental Review of Trading Book (Revision of the market risk framework).
IMA = Internal Models Approach
IRB = Internal Ratings Based
LGD = Loss Given Default
LR = Leverage Ratio
NSFR = Net Stable Funding Ratio (A longer term ratio designed to monitor maturity mismatches over the entire balance sheet).
PD = Probability of Default
RWA = Risk Weighted Assessment
SA = Standardised Approach (The advanced approach is based on an IMA that has to be approved by regulators)
SMA = Standardised Measurement Approach (a standardised way to deal with operational risk).
SCRA = Standardised Credit Risk Assessment (Second alternative approach for calculating RWA). The SCRA requires an assessment of credit risk exposures into three categories: Grade A, Grade B and Grade C. SCRA is usually used when there is no ECRA available. Each grade must have a minimum criterion.
SNOOPY = Snotty Nerdy Outrageous Orderly Puny Yelling
One area that is causing me concern in this "Covid-19 market" is the amount of money that banks have loaned towards business. In particular I am thinking about those businesses not large enough to be listed on any market, yet still large, right down to SMEs (excluding traditional 'really small business' that is likely to be funded by a mortgage taken out over the proprietors home, out of sight of these rules). These businesses do not have externally verified credit ratings. Yet they are still a significant part of the business loan book for any bank.
Using traineeinvestor's supplied reference:
https://www.bis.org/bcbs/publ/d424_hlsummary.pdf
I think such investments are classified under the Standardised Credit Risk Assessment Approach (SCRA) approach. Under SCRA there are three risk weight grades: Grade A, Grade B and Grade C.
Grade A: This grade bucket would include exposures to bank counterparties that have adequate capacity to meet their financial commitments (including repayments of principal and interest) in a timely manner, for the projected life of the assets or exposures, and irrespective of economic cycles or business conditions.
Grade B: This grade bucket would include exposures to bank counterparties that are subject to substantial credit risk, with repayment capacities dependent on stable or favourable economic or business conditions.
Grade C: This grade bucket would include higher credit risk exposures to counterparties that have material default risks and limited margins of safety.
Unlike exposure to retail mortgages, where there are definite risks ascribed based on the amount of equity the home owner holds, these 'grade' classifications seem somewhat wishy washy. Nevertheless, there is probably no reasonable alternative way to rate business loans.
The standardised credit risk table and associated risk weighting for the three grades of loans is as follows:
Grade A Grade B Grade C Risk Weightings 40% 75% 150% Risk Weightings (Short Term) 20% 50% 150%
There is flexibility from the banks point of view as to how each business loan is classified.
"A bank may classify an exposure to a higher-risk grade (ie with a higher risk weight) even if it meets the minimum criteria set out for a lower risk grade, or has not breached the triggers of the higher risk grade."
One might imagine our banks are applying this 'revision' clause right now as they review support for business after the lock down. Yet any damage behind the scenes from such downgrades will also flow through to shareholders. If a business loan goes from 'Grade B' to 'Grade C' the amount of capital required to support such a loan doubles. That must be a huge concern to all bank shareholders! Who could have imagined back in January that a small operator like a dental practice, trading successfully, could be suddenly instructed by the government to close. Would not the bank have to suddenly downgrade such a business's risk profile from 'Grade A" to "Grade B"?
SNOOPY
Guaranteed up to 80% by Government?
Yes there is a scheme for new small business loans to be 80% guaranteed by the government. But I don't think that applies to existing business loans?
However, these government guarantees are a different issue to the one I am raising here. The rating of a loan, be it 'Grade A' , Grade B' or 'Grade C' is dependent on how well a business can operate in a given business environment. Guaranteeing a loan (to 80%) won't change the environment in which the business operates. So for capital adequacy purposes under Basel 3, as far as the bank is concerned. I don't think the government guarantee makes any difference. My interpretation on this point could be wrong. But right now I find myself far from pacified by the governments 80% loan guarantee, in relation to the amount of capital a bank is required to hold to support a business loan.
Of course once a loan fails, that is where the 'benefit' (the bank still must wear 20% of the loan loss remember), comes in. I would love to be wrong on this point though!
SNOOPY
I would very much like to know what the debt to GDP ratio would be estimated at and the impact of this to banks, I can't seem to find any policy document or fiscal forecast from the government!?
From across the ditch...
April 27 (Reuters) - National Australia Bank Ltd (NAB) on Monday announced plans to raise up to A$3.5 billion as it reported a 51% slump in first half earnings and booked A$1.04 billion in provisions,due to the coronavirus pandemic and customer compensation.
Australia's third-largest lender slashed its interim dividend as it also said it would increase forward-looking provisions to more than A$2 billion to bolster its cash position and guard against a hit to business from the outbreak. NAB surprised the market with the announcement, giving just a few minutes notice that it was bringing its earnings report forward from its scheduled May 7 date.
NAB said provisions made to offset a hit to business from the coronavirus, as well as to compensate customers after a series of missteps last year, led cash earnings to slump 51.4% to A$1.44 billion ($919.73 million).
The lender cut its dividend by 64% to 30 cents per share, following a nudge from the Australian Prudential Regulation Authority for banks to reduce or defer dividends and conserve cash amid virus-generated uncertainty.
"We are taking decisive action to manage the rapid and unprecedented upheaval caused by COVID-19 while at the same time being clear about our long term strategy for NAB," Chief Executive Ross McEwan said.
The bank planned to raise A$3 billion in a discounted share placement and about A$500 million through a share purchase plan.