Ex-FDIC Chair Bair: Banks Use Risk Weighting to Manipulate Capital Ratios

Wednesday, 03 Apr 2013 08:24 AM

By Dan Weil

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Banks are manipulating their capital ratios through the use of risk weighting of their assets, says Sheila Bair, former FDIC chairman.

“[These] risk models are common and certainly not illegal,” she writes in The Wall Street Journal. “Nevertheless, their use in bolstering a bank's capital ratios can give the public a false sense of security about the stability of the nation's largest financial institutions.”

Capital ratios should be simple to compute, but they aren’t, Bair says. “That's because regulators allow banks to use a process called ‘risk weighting,’ which allows them to raise their capital ratios by characterizing the assets they hold as ‘low risk.’”

Editor's Note:
 
Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

Bank of America’s recent stress test stands as an example, she notes. BofA reported its capital ratio as 11.4 percent.

“But that was a measure of the bank's common equity as a percentage of the assets it holds as weighted by their risk — which is much less than the value of these assets according to accounting rules,” Bair states. “Take out the risk-weighting adjustment, and its capital ratio falls to 7.8 percent.”

JPMorgan Chase, BofA and Citigroup, on average, risk weight their assets at only 55 percent of their total assets, she explains.

“A strong capital ratio will reduce megabanks' incentives to trade instead of making loans,” she maintains. “Over the long term, it will make these banks a more stable source of credit for the real economy and give them greater capacity to absorb unexpected losses.”

Star bank analyst Dick Bove of Rafferty Capital doesn’t share Bair’s concern.

"In the first quarter of 2013, the banking industry will make more money than in any quarter in the history of American banking," he told CNBC last month.

"You have so much excess capital in the banking industry at the present time that you have to go back to 1938 to find a year in which the percentage of capital to assets was as high as it is now."

Editor's Note: Economist Warns: ‘Money From Heaven a Path to Hell.’ See Evidence.

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