Damien Wood

The recent collapse of a Spanish bank, two Italian banks, and a missed payment on tier one notes from a German bank reinforced some core beliefs for investing in bank capital. These are:-

  • reported capital adequacy does not save a bank – despite the emphasis given by regulators
  • liquidity is of paramount importance when a bank’s solvency is in question
  • for troubled but sufficiently liquid banks, losses can be imposed on bank capital holders and the bank can continue to operate
  • senior bank debt is usually safe – even in financial stress
  • the difference in value between bank subordinated debt (tier two) and preference shares (tier one) in liquidation is usually nil

....So some time in the future when a bank in Australia has high bad loans and the investment pitch is “don’t worry – look at our capital ratio” keep in mind that most banks before they default have had reasonable reported capital ratios.

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