Get familiar with the phrase “well capitalized bank.” It may be the key to the national — and local — economy slogging ahead or diving into the tank.
In a nutshell, banks like Bank of America cannot sustain losses of the size they have in recent months without their minimum capital requirements — as set by federal regulators — being squeezed. As that happens, banks must cut back on lending. No matter the qualifications of borrowers. No matter the relative price stability of any real estate that might be used as collateral. This is the nadir that Charlotte’s local real estate boosters have been whistling past.
Everything that has happened thus far in America’s financial sector is mere prologue compared to a sustained pull back by federally chartered banks bumping up against their capital requirements. Bloomberg explains what is going on:
At the end of last year, Citigroup, for instance, owned $552 billion of securities weighted at zero risk and $523 billion at 20 percent. It also held $320 billion with risk weightings of 50 percent and $881 billion at 100 percent, according to data filed with the Federal Reserve.
To maintain the ratio of 10 percent when a $100 million AAA security is dropped to BBB, a bank’s needed capital would rise to $10 million from $2 million. An institution can raise the $8 million by selling stock or preferred shares. The bank can also compensate by selling the security, or cutting back on other lending.
Regulators focus on two more measures in gauging the health of financial institutions. Well-capitalized banks must have Tier One capital, which excludes subordinated debt and some preferred shares, of at least 6 percent of risk-weighted assets. Additionally, Tier One capital can’t fall below 5 percent of total tangible assets, not adjusted for risk and excluding goodwill, or the extra value of acquired assets.
In some ways the distress in the sector up until this point has primarily involved exotic instruments — derivatives and other artificial constructs that spun out of control. Not so “bank” banks who are doing plain vanilla lending, borrowing, and investing.
Well, if these indications are correct, that is no more. Plus locally we face the double-whammy prospect of job loss if BofA does in fact face belt-tightening for the next few quarters. Again, no need to panic. But it would be prudent to check your financial plans and see if they comport with reality.
Bonus Observation: Psst. Elected officials and high-ranking government employees, this means you.
