Accounting for the future March 30, 2011 at 2:28 pm
Deutsche Bank (HT FT Alphaville) have analysed the fraction of bad assets in the Cajas under various definitions of ‘bad’:
In the Alphaville article this leads to a discussion of the varying amounts of capital the Cajas might need under different scenarios: €15B, €24B, €30B, even €69B. For me though what is striking is the spread of these numbers. Obviously if you give the Cajas €50B and they turn out only to need €15B, you look like a doofus, while giving them €15B for now and hoping that they don’t need more risks having a rolling banking crisis that plays out over three to five years (see ‘Ireland’).
Note that the use of historic cost accounting means that the Caja are solvent under all the possible scenarios until the loans are actually written down, and we know from the example of Japan that that process can be delayed for many years. In other words, part of the reason we don’t know how much capital we need is that we don’t have a precise definition of solvency. The accounting model these banks have means that, at the moment at least, there are literally tens of billions of euros of uncertainty about their solvency. So much for the much vaunted Spanish model.
Update. The Daily Telegraph, commenting on RBS, highlights the same issue:
According to RBS’s latest accounts, which were calculated using IFRS, the bank has tangible shareholder assets of £58bn and core tier one capital of 10.7pc.
Tim Bush … has calculated that under pre-2005 UK GAAP … RBS would have a tangible shareholder assets of £33bn and a core tier one capital of just 6pc.
IFRS … allows banks to disguise the build-up of risks within banks because distressed loans are not reported until they default.
Now I am not sure that this in itself is sufficient reason to move to fair value for the whole of a bank’s balance sheet – that too can be subjective for illiquid assets – but I certainly think that an objective standard with less uncertainty about whether a bank is or is not solvent would be a good idea.