As a banker, I have held the view for the past at least two decades that banking, as a business, is running on excessive leverage and has been poorly capitalized. It was thought banks could handle leverage prudently. Sadly, they cannot.
In any other business, a bank’s balance sheet would not merit even half the debt it is allowed to carry-and I am talking about the United States’ best and biggest banks. Long before the current financial crisis, the government should have done one of two things: mandated that banks should not be leveraged this irresponsibly, or forced them to have a stronger capital base.
To prove my point with some stark facts: one of world’s largest and “stable” banks, Bank of America, on Dec. 31, ’08 had total interest-bearing debt of $1.5 trillion. Their total equity: $178 billion. Which means their equity is only 11.8 percent. This means for every dollar of their own, they borrowed more than eight dollars from their depositors, from government and other banks. By comparison, IBM had interest-bearing debt of $33 billion and equity of $13 billion, a healthy ratio of 39 percent equity.
We routinely demand from businesses that they must have minimum equity of 25-30 percent. Heck, if the poor homeowner did not put down 20 percent of the purchase price as equity, he had to take out expensive insurance against mortgage default. And yet, carelessly, the government has permitted for years for banks to be undercapitalized. No wonder banks, no longer trusting, have stopped lending to each other. Their depositors now trust them even less.
I hope this is a wake-up call. The long-term solution for banks to be healthy is not more regulation or taxpayer hand-outs but simply, a stronger balance sheet, one that has at least a 20 to 25% equity ratio. Even if banks have to get there by accepting the U.S government as a partner.
Shyam Amladi