Gearing Ratios: Trading Company vs Bank

[Snoopy]

No bank CEO knowingly makes a loan that he/she knows will be difficult to repay in a timely manner. Yet we do know that often the first step in a bank loan going bad is a problem with liquidity. Liquidity issues are often resolved by bringing in new capital from somewhere else. This is what I call a 'sideways solution', because bringing in new capital does not necessarily solve the underlying liquidity problem. Rather, the new capital usurps the original problem so the original underlying liquidity issue becomes redundant.

Here then is the enigma for investors concerned with bank liquidity. If the most common way to fix an emergency 'liquidity issue' has nothing to do with manipulating the timing of cashflows of depositors and lenders, does it make sense to study liquidity at all?

Improving the bank gearing ratio by recapitalisation is a 'big picture solution' to liquidity questions. Recapitalisation under these circumstances though, often means that those existing holders of bank equity are disadvantaged, because any new capital must be issued at a greatly discounted price. So although a bank liquidity event is very unusual, the fact that the consequences are extremely severe means I think bank liquidity is worth studying.

From a bank perspective, New Zealand was largely insulated from GFC wash down effects because of the well capitalised Australian parent banks that dominate the NZ banking market. The second tier NZ finance industry, by contrast, was almost wiped out. But just because the NZ Banks survived the last GFC, this should not lead to a complacency that they will automatically survive the next.

The 'headline worry' is that bank customers will lose access to their bank deposits for a while, and even take a 'haircut' on their bank investments. In fact, this is exactly what happened with NZ investors trying to recover their capital from debenture investments in finance companies that went bad. So the idea that this could happen between a customer and their bank while incredible (to those who were around before the GFC) is at least on the horizon as an unwelcome possibility. But is there another loosely connected worry that no-one speaks about and which hides behind a cloud because no-one in the last twenty years has experienced it?

SNOOPY