Amidst all the bluster over the CBA’s bumper profit, The Australian’s Adam Creighton has come out today questioning the long-term safety and stability of the banking system given the low level of shareholder’s capital held by Australia’s banks:
Renowned professors of economics and finance at Stanford University and the Massachusetts Institute of Technology say very large banks with levels of shareholders’ equity around 3c in every dollar of assets are “ludicrously” and “outrageously” undercapitalised.
Only 4.8 per cent of the $2.83 trillion in total assets of Westpac, CBA, National Australia Bank and ANZ is shareholders’ equity, according to Macquarie Bank, up from 4.1 per cent before the global financial crisis. The rest is debt.
Anat Admati, professor of finance at Stanford, is calling for large banks to stop paying out dividends until their capital ratios exceed 20 per cent.
“A highly indebted bank is like an unstable, shoddily constructed building,” she said…
Simon Johnson, professor of global economics at MIT, said Australia should not be too confident it would never have a financial crisis given its exposure to China and resource prices.
While the below data has not been updated for around six months, it does indeed suggest that Australia’s banks are undercapitalised, given the amount of capital held against total credit exposures ranges from only 2.7% (Westpac) to 4.3% (NAB), with capital held against mortgages at around half that level (see next chart).
While this low level of capitalisation has dramatically boosted the banks’ profits by raising their return on equity, it obviously leaves creditors and potentially taxpayers exposed in the event that there is a severe downturn in the economy and asset prices.
