# Big five banks balance sheet health



## james4beach (Nov 15, 2012)

This is a quarterly report on the balance sheet health, not earnings, of the big banks. Good news it looks green - "all's well", but there are some notes about high leverage. Quoted below:

Canadian Credit Health Update 2013 Q2 (click for report)


Big Five bank balance sheet health is stable; impaired loans are low
The banks all have similar leverage, though TD's is the highest at 34:1
The Big Five banks have extremely high leverage at 31:1. Just a 3.2% loss in assets would wipe out equity.
All these banks are undercapitalized according to expert opinion
The banks have $19.2 trillion of notional derivatives, up 3.1% from a year ago
The highest-risk OTC category is up 9.6% from a year ago
The amounts, and growth, in OTC is distressing
Canadian bankruptcy rates continue to decline
Under these conditions (high leverage & derivatives) an unexpected market shock could cause large losses, despite a healthy loan book


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## humble_pie (Jun 7, 2009)

the citation is just another anonymous natter in the chatter.

who is *I* ?

there's no name. He could be anybody from a post-doc in economics to a wack job. Maybe put that another way. He could be a post-doc who's also a wack job.

chart from *GreatPonzi dot com* ?

*expert opinion* on banks' possible demise turns out to be one neil barofsky, nobody else ?

please don't misinterpret my drift. It's extremely useful for cmf forum to have an articulate, consistent Bank Ultra Bear. I for one read all james' presentations diligently. We need pessimists putting the planet's probs under the microscope.

the tiny little problem i have is whomping up anonymous nebbische into expert authorities, then presenting their websites as if their views were the Second Coming.

their views are definitely worth a glance, i agree. But imho should be taken into balance.


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## andrewf (Mar 1, 2010)

I agree that the name of the site hurts their credibility.

On the other hand, I think people (and the market) are a bit too sanguine about the banks sailing through a real estate correction relatively unscathed.


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## CanadianCapitalist (Mar 31, 2009)

andrewf said:


> I agree that the name of the site hurts their credibility.


It's hard to consider any opinion on the site seriously, when one reads things like this in the About page:



> Even something as simple as a savings account at a bank is supported by nothing more than promises. Due to modern fractional reserve banking and leverage, the bank does not actually have the money listed as your account balance. Your account balance is the bank's liability (promise) to you. If a large number of depositors simultaneously demand their money back, the bank may be unable to pay: the money doesn't exist, and it never did exist.


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## kcowan (Jul 1, 2010)

CC
That is a statement of fact. I would not discount the site for stating facts. Banking is a confidence game. And I don't mean a "confidence game"! (Ever since they abandoned the gold standard.)


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## cainvest (May 1, 2013)

Maybe it is a statement of fact but how would a large number of depositors simultaneously demand their money back? 
Also, what is the likelyhood of an event like this occuring?


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## CanadianCapitalist (Mar 31, 2009)

kcowan said:


> CC
> That is a statement of fact. I would not discount the site for stating facts.


Really? Are you saying that the following statement is fact given that we have deposit insurance in Canada: "_the bank may be unable to pay: the money doesn't exist, and it never did exist"?_


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## humble_pie (Jun 7, 2009)

when i was trying to learn something about investing, i was lucky enough to be mentored by a canadian banker working in the euromarket.

he would always talk about the possibility that "the whole deck of cards will fall down." That's how he saw interlocked global banking systems. A deck of cards.

so although it does seem to be an exaggeration to say that banked monies "never existed," nevertheless there is a germ of truth in the hyperbole. Successive waves of QE are masking shaky banks everywhere. 

a gadfly like ultra bank bear james4 is doing us a fine service by articulating a worst-case scenario for banks, which we should all be aware of & should all keep in mind, imho.

let us not forget that the FDIC in the US went bankrupt in the crash of 08/09. It was - & still is i believe - bailed by extra surcharge assessments coming from surviving banks.

it's not impossible that in a meltdown scenario, the CDIC could fail. Early in 2009, one heard rumours that parliament had authorized an emergency CDIC injection of several additional billion $$, which injection was mercifully never needed.


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## andrewf (Mar 1, 2010)

I would go farther and say that it's likely that CDIC would be insolvent in the event of a bank failure. Not that it matters, because CDIC is really just window-dressing for the government of Canada guarantee.


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## james4beach (Nov 15, 2012)

Yes I know the site is anonymous-ish, but these aren't exactly figures being pulled out of thin air. There are references given, and for undercapitalization references pointed to are Barofsky (the TARP auditor), as well as someone at the FDIC.



CanadianCapitalist said:


> Really? Are you saying that the following statement is fact given that we have deposit insurance in Canada: "_the bank may be unable to pay: the money doesn't exist, and it never did exist"?_


Cash balances don't sit at the bank waiting for you to come and pick them up. Banks have very minimal cash balances, and the rest is just a liability on the balance sheet. The bank borrows money from depositors and depositors must trust that the bank is capable of repaying them.

Regarding the CDIC... I think the idea there would be that the CDIC gets unlimited money from the government as needed to repay depositors, so I don't worry about that part. But as far as banks themselves having the cash, they clearly don't -- that's how fractional reserve banking works.


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## james4beach (Nov 15, 2012)

Oh and by the way, I agree the content should be taken with a grain of salt... no doubt! But I think there's still a strong point being made about the high leverage of the banks.


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## james4beach (Nov 15, 2012)

humble_pie said:


> when i was trying to learn something about investing, i was lucky enough to be mentored by a canadian banker working in the euromarket.
> 
> he would always talk about the possibility that "the whole deck of cards will fall down." That's how he saw interlocked global banking systems. A deck of cards.
> 
> ...


humble_pie, I appreciate your willingness to at least look at the worst-case scenario.

According to their annual report, the CDIC has $2.5 billion in assets. They insure $622 billion of deposits. On average at the big five banks, 34% of their deposits are CDIC insured.

I think CIBC has the least deposits at $307 billion which means approximately 34% x 307 = $100 billion of insured deposits. So clearly if CIBC were to fail, there will be problem paying out depositors... CDIC has less than 3% of the insured amounts, and that's just at CIBC alone with the smallest deposits.

Thus depositors have to trust that the government would produce the required amount of money, which in the case of CIBC would be the $97 billion shortfall after CDIC is depleted. If it's a larger failure, government has to produce much more money. Obviously the government doesn't want the bank to fail to begin with and would probably prevent this from happening through all means... which again is why we find ourselves in this situation where the banks operate with reckless high leverage yet nobody seems to care.


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## humble_pie (Jun 7, 2009)

james4beach said:


> Regarding the CDIC... I think the idea there would be that the CDIC gets unlimited money from the government as needed to repay depositors, so I don't worry about that part.


i wonder, though.

during the 08/09 crash, economist Anthony Boeckh said he believed that the CDIC would be able to bail one canadian chartered bank. The problem would be that, in a global financial collapse, more than one bank would fail. He suggested 2 or even 3 out of the top 6 might fail.

i don't really see how the CDIC could get "unlimited" money from the government. We've never seen the chaos that would result from a multinational financial breakdown. The social upheaval - riots, guns, breakdown of medical services, disruption of clean water & food delivery systems - would be endemic.

every canadian would be in trouble. In such a situation i can't imagine members of parliament voting to give CDIC more $$ in order to help the already affluent clients of banks. Government would already have too much trouble just paying the army to maintain law & order.


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## andrewf (Mar 1, 2010)

Wouldn't there be some time in between financial stability and Mad Max-esque social breakdown? I don't think that happens overnight.

In a pinch, there's no shortage of Canadian dollars. The government can borrow arbitrary amounts from the bank of Canada.


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## CanadianCapitalist (Mar 31, 2009)

james4beach said:


> Cash balances don't sit at the bank waiting for you to come and pick them up. Banks have very minimal cash balances, and the rest is just a liability on the balance sheet. The bank borrows money from depositors and depositors must trust that the bank is capable of repaying them.
> 
> Regarding the CDIC... I think the idea there would be that the CDIC gets unlimited money from the government as needed to repay depositors, so I don't worry about that part. But as far as banks themselves having the cash, they clearly don't -- that's how fractional reserve banking works.


I understand perfectly that banks don't have all the depositor's cash on hand. I've seen _It's a Wonderful Life_ too. IMO, one loses much credibility if one mentions bank runs without mentioning deposit insurance. To me, that person is not a bank bear anymore, just another nut bar.


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## james4beach (Nov 15, 2012)

CanadianCapitalist said:


> I understand perfectly that banks don't have all the depositor's cash on hand. I've seen _It's a Wonderful Life_ too. IMO, one loses much credibility if one mentions bank runs without mentioning deposit insurance. To me, that person is not a bank bear anymore, just another nut bar.


I see what you mean. Yes that page doesn't mention CDIC anywhere.


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## james4beach (Nov 15, 2012)

humble_pie said:


> i wonder, though.
> 
> during the 08/09 crash, economist Anthony Boeckh said he believed that the CDIC would be able to bail one canadian chartered bank. The problem would be that, in a global financial collapse, more than one bank would fail. He suggested 2 or even 3 out of the top 6 might fail.
> 
> ...


You maybe painting an overly pessimistic scenario. I imagine that before a bank failure, the Bank of Canada would have printed plenty of money (adding liquidity) so maybe the BoC actually supplies a lot of the depositor money.

Maybe it's best to look at the US example with Washington Mutual, the largest failure in US history. The wikipedia page says after the troubles hit, depositors withdrew $17 billion of deposits and then the bank failed. The FDIC didn't want to take the deposit liabilities and was able to find a larger bank (JPM) who bought the assets and took the deposits too. So in the end the FDIC didn't pay out deposit money.


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## fatcat (Nov 11, 2009)

regardless of the name of the site which gives one immediate pause, the numbers are helpful and accord with what i have gleaned from reading elsewhere

i.e. royal bank is doing a lot more investment banking and out-of-country-deals than cibc and thus has more derivative exposure

whereas cibc has the least amount of derivative exposure because it is doing more mortgage lending in canada and thus is overexposed to a housing crash whereas royal isn't

i lightened up my bank exposure and moved some into insurance partly because of our resident chicken little's (thank you for that james) posts :rolleyes2:, which like pie, i also read

i sold cibc and bought power some weeks back


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## humble_pie (Jun 7, 2009)

CanadianCapitalist said:


> IMO, one loses much credibility if one mentions bank runs without mentioning deposit insurance. To me, that person is not a bank bear anymore, just another nut bar.



CC i don't mean to be a crank here, even though i might sound like just another nutbar pie.

but they had bank runs in scotland only a few years ago. Northern Rock. I don't know how much money customers got back.

they had bank runs in iceland. AFAIK the icelandic people got back zip.

i have no idea what's happening in cyprus right now. 

these are first world countries. In 3rd world countries i'm more interested in what is going to happen with the cohorts of 16-25 year olds who will have no jobs. In greece herself, unemployment is north of 50%, they say. In countries like waziristan or somalia, the choice is al-quaeda or opium or piracy.

desperately unhappy youth cohorts are, in part, an outgrowth of broken social systems harboring broken banks & broken financial institutions imho.


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## james4beach (Nov 15, 2012)

That's right, first world countries do have bank runs. They had bank runs in the USA too. People literally lined up on the streets to withdraw from Indymac bank. And Washington Mutual was more of an electronic run on the bank, $17 billion withdrawn in 10 days!


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## CanadianCapitalist (Mar 31, 2009)

humble_pie said:


> but they had bank runs in scotland only a few years ago. Northern Rock. I don't know how much money customers got back.
> 
> they had bank runs in iceland. AFAIK the icelandic people got back zip.
> 
> i have no idea what's happening in cyprus right now.


It's legitimate to worry about these things. All I'm saying that is that it is not credible to say banks are giant ponzi schemes because of the possibility of bank runs without also mentioning deposit insurance. I have no idea what sort of deposit insurance is available in Cyprus or the UK. AFAIK, we did not have banks failing in Canada. But in the US, which has a similar banking system to ours, there have been a number of failures. Are you aware of a single penny lost by depositors in any of these failures?


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## fatcat (Nov 11, 2009)

CanadianCapitalist said:


> It's legitimate to worry about these things. All I'm saying that is that it is not credible to say banks are giant ponzi schemes because of the possibility of bank runs without also mentioning deposit insurance. I have no idea what sort of deposit insurance is available in Cyprus or the UK. AFAIK, we did not have banks failing in Canada. But in the US, which has a similar banking system to ours, there have been a number of failures. Are you aware of a single penny lost by depositors in any of these failures?


i lived in the usa for a long time and banked at a bank that failed ... if there wasn't a notice on the door from the fdic, you would have been hard pressed to know that _anything_ had happened at all ... the bank opened on time on monday after failing over the weekend and it was business as usual until the sign was changed to the bank that took it over ... there is a very high degree of faith and confidence in the fdic in the usa, zerohedge and others notwithstanding


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## andrewf (Mar 1, 2010)

In Iceland, depositors were covered under deposit insurance. Iceland did not guarantee deposits of foreign subsidiaries (Icelandic banks had online deposit taking operations in the UK and Netherlands). The UK and Dutch governments ended up guaranteeing the deposits of their residents.

http://en.wikipedia.org/wiki/2008–11_Icelandic_financial_crisis

I can't see governments failing to guarantee deposits. They'd be better off wiping out equity and bondholders before defaulting on deposit guarantees.


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## sags (May 15, 2010)

Depositor insurance becomes a non issue..............when governments can simply claim the deposits outright.


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## fatcat (Nov 11, 2009)

andrewf said:


> In Iceland, depositors were covered under deposit insurance. Iceland did not guarantee deposits of foreign subsidiaries (Icelandic banks had online deposit taking operations in the UK and Netherlands). The UK and Dutch governments ended up guaranteeing the deposits of their residents.
> 
> http://en.wikipedia.org/wiki/2008–11_Icelandic_financial_crisis
> 
> I can't see governments failing to guarantee deposits. They'd be better off wiping out equity and bondholders before defaulting on deposit guarantees.


agreed, the moral hazard seems extreme ... the people that are savers and have modest savings tucked away in the bank would be the last group you want to take it on the chin ...


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## andrewf (Mar 1, 2010)

sags said:


> Depositor insurance becomes a non issue..............when governments can simply claim the deposits outright.


But they won't do that. Worst case, the government of Canada has access to unlimited Canadian dollars via money printing. Why would they annihilate the financial system by seizing deposits?


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## My Own Advisor (Sep 24, 2012)

I'm wondering the same thing. Wouldn't our government just print a bunch of money and de-value?


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## james4beach (Nov 15, 2012)

james4beach said:


> The banks all have similar leverage, though TD's is the highest at 34:1
> The Big Five banks have extremely high leverage at 31:1. Just a 3.2% loss in assets would wipe out equity.
> All these banks are undercapitalized according to expert opinion


Zerohedge famously brought up this same issue back in 2011, when they pointed to the Canadian banks as some of the highest leveraged in the world (most poorly capitalized)
http://www.zerohedge.com/news/next-domino-fall-canada

There were rebuttals to Zerohedge in the Globe & Mail. Back then the experts argued that Zerohedge was being silly using assets instead of risk-weighted assets. Since then several high profile people have come out supporting the tangible equity:total assets technique. Basically the calculation that Zerohedge used, and this article I posted from greatponzi.com uses, have quite a bit of expert support behind them that didn't exist back in 2011. It's increasingly looking like that number used by regulators -- ratios based on risk weighted assets -- are the wrong, silly ones.

Here was zerohedge's rebuttal the Globe & Mail's challenge of its numbers:
http://www.zerohedge.com/news/who-john-paulson-and-why-should-globe-and-mail-care

Here is what John Paulson wrote about the American banks when they had 40:1 leverage. Note that TD Bank, using the same calculation, has 34:1 leverage today. The criticisms can be applied to TD and other highly leveraged Canadian banks:



> John Paulson: The problem with financials is that they are very leveraged and don’t have enough tangible common equity to absorb anticipated losses. Large American and European banks have on average 40:1 leverage, defined as Total Assets / Tangible Common Equity. The Tier 1 capital ratios commonly used by banks present a misleading picture as to the capital adequacy of banks. The Tier 1 ratio includes preferred stock, hybrids and subordinated debt as capital and then risk weights assets, leading to a risk weighted asset number that is much less than the total asset number. This can lead to a situation where banks have high Tier One Ratios but very low tangible common equity ratios (see graph below). As a common shareholder, we only care about tangible common equity.


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## Eder (Feb 16, 2011)

I'm no expert but anyone that has let Zerohedge influence their investments has let a lot of $ get away. The sky is always falling and things like that...gets old fast. I guess if swing trading its important to see if RY missed by 2 cents or hired some foreign contract workers, but if you ever want to retire they will make an investor rich.


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## kcowan (Jul 1, 2010)

CanadianCapitalist said:


> I understand perfectly that banks don't have all the depositor's cash on hand. I've seen _It's a Wonderful Life_ too. IMO, one loses much credibility if one mentions bank runs without mentioning deposit insurance. To me, that person is not a bank bear anymore, just another nut bar.


I think the best thing you could advise anyone who trusts the banks that they never deposit more than what is guaranteed, e.g. $100K. This is because they don't have the money to pay 100% of any extra money on deposit. That is the essence of fractional reserve banking without a gold standard.

(Granted the Canadian banks seem to be the best of the lot. Yet I don't see any knowledgeable people recommending having more than the guaranteed amount on deposit.)


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## doctrine (Sep 30, 2011)

> I'm no expert but anyone that has let Zerohedge influence their investments has let a lot of $ get away.


The average big bank had an 18% return in the last year including dividends, which grew by an average of 7.4%. Cash returns aren't making their balance sheets any worse. The Tier I Capital ratios are improving amongst every one of the banks and all 6 are already at the level they are required to meet by 2016, with 3 years to go.


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## sags (May 15, 2010)

andrewf said:


> But they won't do that. Worst case, the government of Canada has access to unlimited Canadian dollars via money printing. Why would they annihilate the financial system by seizing deposits?


A few billion here or there, I would agree but if the problem was much bigger, than I would have to disagree.

The US can print money and get away with it.........because other nations let them.

Canada would not be as fortunate.

Printing money would make Canadian dollars worthless in a hurry. Stealing depositor assets would drive money out of the country, but wouldn't trash the currency.

The only people who care about the government seizing deposits from the wealthy.........are the wealthy.

Everyone would care about a Canadian dollar that was worthless.

It is all kind of irrelevant anyways. If it every got that bad.........anarchy would rule.


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## andrewf (Mar 1, 2010)

I think you underestimate how much money printing the government could do. $100 billion no problem--the dollar would drop in a bank failure scenario no matter what the government does. We borrowed $100 billion in the last few years with falling bond yields.


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## james4beach (Nov 15, 2012)

doctrine said:


> The average big bank had an 18% return in the last year including dividends, which grew by an average of 7.4%. Cash returns aren't making their balance sheets any worse. The Tier I Capital ratios are improving amongst every one of the banks and all 6 are already at the level they are required to meet by 2016, with 3 years to go.


Nobody is disputing the profitability of the banks... they are clearly doing well. Anyone who is highly leveraged into the right investments will do very well. The problem is what happens when their assets go sour or an expected problem hits such as European bank instability... leverage amplifies the losses too.

Tier 1 capital ratios look good, yes, but many experts now say that Tier 1 capital ratios are not a good way to measure a bank's risk. That ratio is based on risk-weighted assets, and these experts I mention say that such risk weightings are easy to manipulate for favourable outcomes by the banks. Also "Tier 1 capital" includes many intangible things that really shouldn't be included as capital.

My point is that just because bank capital ratios look good, and just because the regulator says they are adequate, does not mean the banks are appropriately capitalised. Among the voices attacking this issue are
- Thomas Hoenig of the FDIC
- Sheila Bair, formerly FDIC
- Neil Barofsky, former Special US Treasury Inspector General of TARP
- Andrew Haldane, Bank of England
- John Paulson, a large hedge fund manager

So don't take my word for it. According to all these experts, the risk-weighted capital measures used everywhere (including Canada) aren't the best way to measure capitalization. And when you use the better metric that they suggest, that's when you see very high leverage numbers like 31x for the Canadian banks, which is "Lehman territory". Strictly speaking I think Lehman's was 40x at the time of failure, according to Paulson.

I'm not satisfied that the regulator says that the banks are sufficiently capitalized. Personally I'm convinced, by the above people, that the Canadian regulator doesn't use a very good metric and it's giving us an overly optimistic sense of the situation with our banks. When you apply the better metric, our banks turn out to be very highly leveraged... with TD getting up near Lehman's 40x.


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