There Is No Such Thing As A “Safe” Big Bank

bankShah Gilani: Thank goodness we have the FDIC and the Federal Reserve and Congressmen and women.

Thank goodness they’re willing to tap the captive citizenry for as much cash as they need to back the Fed and the FDIC to safeguard our big, beautiful banks from… themselves.

Only, there’s a problem.

Big bank “safety” is only a myth.

And if you think the latest Basel Accords – we’re up to Basel III now, developed after the 2008 financial crisis – will make them “safer,” I’ve got a bridge in Brooklyn I’d like to sell you.

Remember, the Basel Accords are drawn up by a group from the Bank of International Settlements, basically central bankers, who want to set the standards for bank safety. In yesterday’s story, I pointed out that Basel I made securitization the Holy Grail. And that Basel II, which was even tougher on poor banks, gave them the right to use their own “models” to calculate what risks their “assets” posed.

Well, in keeping with their all-the-time-tougher standards, the new proposed rules in Basel III call for still-higher capital ratios.

Will it never end…? These poor wee banks are always up against tougher and tougher standards! This assault has gone too far.

Prior to the financial crisis, banks had to have a 3% capital ratio (also known as “capital adequacy ratio”), which is the percent of assets funded with equity. Obviously that wasn’t anywhere near high enough to safeguard banks when all Hell broke loose. But rest assured, the hard-nosed Basel Committee – who some skeptics (know any?) say are shills for the banks – stepped up again for our collective good and have now mandated a 4% capital adequacy ratio.

Oh, the humanity!

Things are now so dicey for the future of big banks that Senator Richard Shelby, the ranking Republican from Alabama on the Senate Banking Committee, wants a law that requires an extensive look at Basel rules before they crimp American banks into shrinking bonus pools and other ensuing tragedies.

Shelby, who might be considered a “friend” to the bankers, or a “lover,” whatever, thinks the new Basel rules could cause capital levels to fluctuate even more. He’s so worried, he introduced legislation last week to prevent regulators from passing them without conducting a study first. He wants to know, would risk-weighted assets rise or fall? And more importantly, he wants to know what impact any rule changes regarding what internal bank modeling management tools can be used will have on lending… at a time where banks need to be flush with cash to lend.

He’s my hero, Richard Shelby. Especially the way he trades. With only a modicum of insight on the markets, given his full-time attention to being a senator and having to learn all about what’s going on with banks and banking and stuff that could move markets, or options, whatever, he manages to have an enviable trading record. Just ask “60 Minutes”…

I wonder, what’s the point of Shelby trying to delay the implementation of Basel III into infinity when it’s infinitely stupid in the first place? Is he looking for more campaign money?

U.S. banking regulators have already looked at the new rules and issued reports on their impact.

The Fed’s own analysis by its division on banking supervision and regulation said last fall (to lawmakers on the Hill) that the majority of banks would not have to raise any additional capital (a big fear of Richard Shelby’s), because they already meet the minimum new standards under the proposed rules. Michael Gibson of the Fed testified that even 90% of community banks meet or exceed “proposed buffers.”

It’s all rubbish, or worse, but I can’t use that language here.

You see, the truth is, it doesn’t matter what the ratios are. Banks were given the right to manipulate their books when they got the right to use internal risk-modeling math (hocus pocus) to tell the regulators what their capital ratios are.

As usual, the bankers and their shills are crying that new standards are tough on them (they’re not), but they don’t mention that they now rely even more on their own internal risk-weighting scales to lie about their true state of being.

FDIC board member Jeremiah Norton says banks’ reliance on internal models “do not adequately capture risk.”

How off are they when it comes to being honest about how risky their “assets” are?

Sheila Bair (who I love, because she is the only person who always tells the truth), the former Chairwoman of the FDIC, penned an opinion piece in The Wall Street Journal on April 1, titled “Regulators Let Big Banks Look Safer Than They Are.”

It was no April’s Fool joke.

On the subject of banks risk-weightings being bunk (my word, not hers), Bair points to the latest Fed stress tests. Bank of America says it its capital adequacy ratio is 11.4%, but Bair says if you take out the nonsense (my word) internal modeling of risk-weighting adjustments, their real ratio is 7.8%.

Morgan Stanley came out looking good with a 14% ratio, which, when wrung through the honesty rollers is really 7%.

Bair points out that banks generally risk-weight at 55%. That means they have a trillion dollars’ worth of assets, and they say their models show that they only have risk on 55% of that book.

What’s in the book they juggle? Oh, that would be securities and derivatives.

Let me make it simple, because it is. These liars are saying that the riskiest stuff on their books – the stuff that Basel I said they didn’t have to hold as much capital on, because this stuff could be traded away and out the door before it could be a problem – the same stuff that brought us to the edge of financial Armageddon – is adequately modeled internally to reflect their true risks and that their homespun capital adequacy percentages make them safe.

And of course, it’s even worse than that…

Banks assign a “zero risk” to their holdings of U.S. government paper and a 20% risk-weighting to other big banks’ debt.

Well, thank goodness there is no risk in holding U.S. government bonds (what’s a little deficit here or there or a downgrade here or there?). And as Sheila Bair (I love you) points out, “The rules governing capital ratios treat Citibank’s debt as having one-fifth the risk of IBM’s.”

In case you missed the point, she is saying, “In a financial system that is already far too interconnected, it defies reason that regulators give banks such strong capital incentives to invest in each other.”

There you have it. The banks are safe, and myth-busting is nothing more than an internal model gone awry.

Sleep tight… on top of that lumpy mattress stuffed with cash.

Related: Direxion Daily Financial Bear 3X Shares (NYSEARCA:FAZ), Financial Select Sector SPDR ETF (NYSEARCA:XLF), Bank of America Corp (NYSE:BAC).

Money MorningWritten By Shah Gilani From Money Morning

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