Calculated Risk on Liquidity and Solvency

The invaluable Calculated Risk has a couple of very useful posts on the analytics of bank solvency and liquidity here and here.  The discussion is framed around current US policy but is still very useful reading for those looking for a starting point for understanding the issues facing the Irish banks.

6 thoughts on “Calculated Risk on Liquidity and Solvency”

  1. Karl,

    Calculated Risk distinguishes between the “Geithner-Zombie bank” approach and the “FDIC-Preprivatization” approach to insolvent banks, naturally favoring the latter, as we both do too (and have said so several times on this blog).

    But it seems to me that the NAMA scheme provides a framework that, if operationalised correctly, can be used to implement such an approach in a flexible way–not least by providing a mechanism for valuing the banks’ assets, determining who, if any, are solvent and who are not, and providing for an orderly restructuring.

    The “illustrative” discounts presented by NTMA suggest that they realize that the NAMA-driven write-downs will be approximately equal to current book equity.

    If so, the process will surely leave the Government as a large majority or sole shareholder until the banks can be resold into the private sector.

    I am sure you will agree that, if done properly, this process would be a cleaner and more comprehensive way of dealing with remaining insolvent banks than that adopted for Anglo Irish.

    BrianL may think me jesuitical, but details do matter when it comes to issues of this magnitude.

  2. @Patrick H
    Brian Lucey or Lenihan 🙂
    Its not at all clear to me Patrick that NAMA will in fact solve the pricing problem. I dont have the answer but I do have, with Constantin Gurdgiv, an answer in Business and Finance , on pricing.

  3. Thanks Patrick. Just to clarify, though, I wasn’t intending that our readers would find much in CR’s posts to enlighten them on the finer details of NAMA! They’re just nice short clear pieces with good graphs which may help people to understand some of the basic conceptual issues.

    My sense is that even many financial journalists have trouble understanding the meaning of bank capital or what is meant by solvency and illiquidity, and pieces like this may help.

  4. OK this might seem like an obvious thing, but I’m confused by the stock element of tier 1 capital. While you’re helping us finance muggles perhaps you could help?

    My understanding is that T1 capital is stock invested in the bank + retained profits. I call this my understanding, but frankly I don’t get how stock invested is considered. Presumably most of the capital invested in the bank is long gone by now? Is it still important for older banks like our big two?

  5. Marcus
    The original capital still should exist and can be found by following the double entry: credit shares, debit cash. The bank on day one has now an asset that it can lend out industriously!

    But once it does, the cash is now nil and the asset is the loan to the customer. Luckily, as this is an academic example, the customer has bought something from a person who has deposited that money with the bank. So we have the same cash but a corresponding credit of owing it to the second customer. The assets of the bank change but usually grow…. The capital increases in such cases, as the profits on the loans, the interest rate in our simple example, accumulate year by year. But we also have dividends on our shares and losses as loans go bad. Then it wipes out our capital but only when we allow our accountants to recognize it. Until then we are solvent, just so long as we have the cash we need for day to day ops and to repay, this is key, the commercial paper which is short term but specific and usually large. Once we fail to meet such a repayment, we is bust. Even if we had capital, another example, no losses wiped it out, we could still be illiquid but the CB would lend us the money needed as lender of last resort. But even it runs out of money eventually……. any day now!

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