Highlights from the Bank of England financial stability report

The Bank of England recently published its bi-annual financial stability report for November 2012. As usual it contains some very interesting stuff. Let me highlight a few things.  The first thing I want to highlight is the graph below on bank capital requirements. It shows an interesting comparison, namely what the shortfall in bank capital looks like when capital is calculated in different  ways. It shows that the risk weights that result from banks’ internal rating-based models are significantly lower compared to those resulting from alternative measures for required capital. According to the BoE this could indicate that capital levels in the UK are currently overstated. Regulators in other EU countries should follow this lead (and publish their results).

The second thing I want to highlight is the BoE view on equity issuance. I quote ‘Since the early stages of the financial crisis, large amounts of equity have been issued by banks. (…) This suggests low bank valuations are not of themselves an obstacle to issuing equity.’ The graph below substantiates this view. It contrasts with the line I’ve heard from other central banks, who regularly argue that banks can only recapitalize by withholding dividend or shedding assets. Of course, banks do not like issuing equity and would rather spare their stockholders. But from a social perspective issuing capital is the preferred way of recapitalizing.

The third thing I want to highlight is the graph below on Greece. It shows the projection of development of Greek GDP at different stages in the eurocrisis. Note that these projections are consistently over-optimistic.  Based on this graph, you may guess what the answer will be to the question: ‘Will we need further debt reductions for Greece?’.

How Spanish banks’ equity dropped steadily since 1992

A recent working paper by Alfredo Martín-Oliver, Sonia Ruano and Vicente Salas-Fumás from the Spanish Central Bank nicely illustrates how equity of (Spanish) banks slowly melted away over the past two decade. In 1992 Spanish banks held on average 12% equity capital.  In 2007 only 5% remained (top graph). Unsurprisingly, the solvency ratio – which involves risk-weighted assets – dropped much less, from somewhat more than 17% in 1992 to roughly 14% in 2007 (bottom graph). The ratio of risk-weighted assets to total assets has been dropping steadily over the past two decades for banks from all countries, see my earlier post on this paper.

Interestingly, the paper also contains a lot of information on the distribution of equity, showing that bank equity levels have been converging. In 1992 the gap between banks with 10% highest equity level and banks in the 10% lowest categorie was more than 15%. In 2007 this gap was reduced to roughly 6%.