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It looks like the IASB is really interested in our opinion on the own credit risk issue. If you want to give them your opinion (and mine is pretty clear) then you need to become a registered user of the IASB website (come on – you know you are really interested and you do not have to admit it to anyone) and then email them at “”.

It would be worth doing if it gets them to a sensible position. Of course, many banks and other enterprises may find it “sensible” to allow the inclusion of own credit risk in the value of a liability – it would serve to reduce the disclosed value of the liabilities of the company, perhaps taking a failing enterprise to a position where they are then able to show a positive net worth. It would also improve the capital position of banks.

That would be a truly perverse outcome.

Following a suggestion I have been reading a book by Naomi Lamoreaux on the development of banking in New England1. It is called Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England.

She makes a number of excellent points in the book, and, to me, anyone with an interest in the development of modern banking should give it a look. Quite a few of the points she makes relate to the way that the improving understanding of credit risk, and the development of modern risk management, was, to a large extent, responsible for the development of modern, large banks.

I would argue, consistent with my earlier post on regulation, that it was not solely this, as an increase in regulation did play a major part, but I think it was more of a virtuous (or perhaps vicious) circle – with an increase in the size of banks, and an increasing ability to lend to whoever happened to turn up to the bank driving further regulation – which then effectively forced the smaller banks to grow or perish – creating more regulation.

The central point of the book is simple – early banking in the US (and, she presumes, elsewhere) was severely hampered by an inability to assess credit risk, so what happened was when a bank was founded it generally had several directors, men (and they were all men) of substance who effectively both lent their names to the bank and risked a large part of their fortunes in the venture.

In return, what they got was access to the banks funds, with a typical bank lending between 20 and 50% of its funds either to the directors or family members of the directors – the “insiders” of the title. They were, to an extent, protected from unlimited liability by the bank’s charter, but  this protection was often more illusory than real as to default would normally not only spell the end of the bank, but also the reputation of the individual directors.

The result was that the directors typically had an overwhelming say in the allocation of the bank’s lending, and they often lent to themselves or to others they knew well.

While today this may be looked on askance (and as possible criminal activity) then it was considered normal business for the reasons set out above. The difficulty of assessing credit risk meant that only lending to people you knew well (and, presumably trusted) was reasonably safe and, as you effectively had your own money on the line, you wanted to be really safe.

This had several effects – most people were effectively locked out of the banking system until they reached a point where they were rich enough to either own their own bank or to know someone who did. The second was that banks tended to be small – really small – with around 6 directors each and few employees. They also tended to have really high capital and liquidity ratios and charge really big margins. This then locked still more people out of the borrowing market.

The development of modern risk management practice, in all fields but particularly credit risk management, put paid to this model. While a few micro banks lingered into the modern era (and a few unit banks survive in the US) the bulk either went out of business or were bought out in the period up to the first world war.

The simple fact is that bigger banks, once you can overcome the difficulty of finding the good risks to lend to, are much, much more efficient2. If you can lend to more people, and people you do not personally know, you do not need your (comparatively expensive) directors to take every decision. You can directly obtain diversification benefits, cutting down losses per dollar lent. You can also, as a consequence, reduce your liquidity and capital ratios so you can drive more lending off the same amount of deposits (not, of course, that you can lend more than you have in deposits) and you can generally make more money.

For those campaigners for “social equity” it also makes a clear point – without modern risk management the poor are effectively locked out of the banking system entirely – so if they want (or need) to borrow funds they need to go to the loan sharks to get one. Personally, I would prefer to pay 6 to 10 percent to a bank than 20 to 50 percent to a loan shark. The bank also tend to not threaten to break my legs for non-payment. Banks can be funny that way.

The directors also become much more removed from the day-to-day operations,becoming more like the modern directors of a bank, able to reduce the risk to their own personal assets that may result from a bank collapse.

I would encourage readers to have a look for this book and give it a read, as it fills in a hole often left in the discussions on the development of modern banking.


1. For those not familiar with the term, or who may be thinking of another New England as there are several, she means the US states to the north east of New York.

2. They can also, as I pointed out earlier, deal with the regulation better, and they can lobby government more effectively – i.e. be more efficient rent seekers.

I will very irregularly have any time for a full post over the next few weeks due to work pressures. I seem to be spending most of my time here trying to sort out one commenter on what I believe to be his misunderstandings of banking. Oh well.

Just for your reading pleasure, though, I read a very good post regarding the role and future of the Credit Ratings Agencies on the usually excellent “The Sheet” today. Have a read – it is worth it.


The agencies proved that they are poor at rating complex structured finance products. Their approach to rating sub-prime mortgage backed securities was not sufficiently rigorous and their models for assessing other more complex products were inadequate.

By virtue of this, their opinions on these products should now be viewed as being of little value and the market should effectively withdraw the agencies’ ‘licence’ to rate such products. This will open the door for new specialist structured finance ratings agencies to enter the market.

This seems a better approach than more regulation and the unintended consequences that could result.

If you are in the business of reading banking news on a regular basis please subscribe. It may help in your understanding of what banks actually do.

The recently released announcement of losses within BankWest really makes very little sense to me. The entire loss is attributable (according to the release) to costs arising from the East Coast expansion strategy (which will presumably now be stopped) and, more importantly, loan impairments – up from $88m to $825m.

This is a huge jump – and one I simply cannot understand. As they were foreign owned and never had to produce a single Pillar III release under Basel II I cannot work off any real numbers, but looking to a peer comparison they must have been doing something seriously wrong under the old management for them to have had such a jump.

Not a single one of their competitors has reported anything like this increase in impairment provisions over the last year. Not one. The worst (incidentally, CBA) had them roughly triple in the September to December 2008 period – probably the worst of it. Considering the size of BWA’s retail book in WA (certainly better performing than the East Coast) to me at least this would mean that the losses over East must have been astronomical.

I just can’t see it. Feel free to correct me in comments, though.

I was asked yesterday about capital charging – and I started talking about transfer pricing. Whoops.
Without going into a full description of banking capital, I would like to set out a few basics on capital charging, my philosophy on how it should be done and (tomorrow) some of the effects of this on the current system.

Banking Capital

The first decision you need to make is whether to use economic, regulatory or total capital. In deciding the level of total capital, it should be above (by a certain margin) whichever of economic or regulatory is the higher. If we assume that regulatory capital is the higher (a fairly safe assumption) you get the following:
Total Capital > Regulatory Capital > Economic Capital

The reason for this fairly simple – if you are operating below your regulatory capital then the regulators will (or should under the law) insist that you increase your capital level or they will move in and shut you down. Regulators normally insist on more capital being held than is conventionally prudent, and the economic capital value is what you would choose to hold if you were being conventionally prudent (i.e. within your risk appetite).

The important question when internally charging for capital is which of these to use as the correct value for charging? Read the rest of this entry »

I was asked a question today that I thought would be interesting for the general readership – to see what approaches were being used. To quote the question:

My … question for you is regarding retail pooling……as you know, when we implemented in <deleted>, each exposure was individually assessed and the pooling approach was not adopted.
Given that SMEs have the ability to fluctuate between Corporate and Retail classifications, how does that work from a model perspective for banks that have adopted the pooling approach for retail? For example, a business is assessed using a non-retail application scorecard as it meets corporate criteria and a PD is calculated. If that business then ceases to meet the corporate criteria would it then need to be allocated to a Retail pool? Then what happens if it pops back into the Corporate bucket?
I can only assume that this is not dynamic managed and that there would need to be some manual reclassication / reassessment of the exposure.

I know what my response would be, but I would be interested to see what approaches are being adopted outside my own little world. Comments?

Given that these disclosures have started to settle down into a slightly more regular pattern, I will be expanding my analysis to look at more areas. In particular, I intend to look at what the actual content of the numbers is saying about the risks embedded in each of the banks. As the vast majority of the numbers relate to credit risk, this is where I am forced to concentrate.

Firstly, though, a big warning to all. All of these numbers below are based on the disclosed numbers as I have read and, in some cases, aggregated them. They are not in any way official numbers from the banks and you should go back to the source documents (as linked previously) if you want to look at them seriously. As all of the tables I have used have some variations across each of the documents I may have mis-interpreted the numbers in some way. If you spot one, or merely have a question, please put it in comments or contact me on the email address given on the “Authors” page.

There are also a few oddities in the data that make me question my own numbers. So, please, do not rely on these and I will not be interested in any claims that you made any financial decisions based on the below. It’s a blog post, for heaven’s sake.

Disclaimer over – on to the numbers.

Read the rest of this entry »

You would have heard me by now praising CBA’s disclosures, so I will not bore you again with them. OK, I will – yay, CBA. Keep at it. It is just a pity the government guarantee means that you will not be rewarded for it, but, chin up, it will go soon (I hope).


Just a quick reminder here, though. All of the numbers and discussion below is given relative to other banks in Australia. If you compare these numbers to almost any other in the world today you will find the Aussies are far better than most. None of the Oz banks are even trading close to making a loss. Westpac, for example, had the best return on equity of any major bank anywhere last year – and the others are not far behind.


The numbers from these two, though, are a study in contrasts, While they have much the same sized portfolio overall (NAB is slightly bigger overall), CBA is more weighted towards the housing end and NAB towards business. In the good times, this served the NAB well in profitability, but it is now hurting in terms of impaired assets and arrears. NAB, despite having only about 16% bigger book (in EAD terms) has about 50% more impaired assets. It also has more loans at over 90 dpd, although CBA, because of its bigger book size, has more residential mortgages overdue. Oddly, though, this has not followed through into the impaired category. My guess here is that many of the NAB’s residential mortgages were used to back business loans, which have been more likely to get impaired quickly.

The rest of the assets story is more or less as you would expect. NAB has many more of its assets in the Standardised categories, mostly because they have substantial overseas assets that they (presumably) have not been able to get a model approved for as yet. If they do not soon do so it may make sense to dispose of them to someone that can.

Overall, 22% of their assets are held in Standardised portfolios, as opposed to 6% average for the others. more work required here, I would have thought.

None of the rest is startling, So I will put some more push into completing the analysis on the overall comparison.

… are now coming out. Westpac looks to be the first off the block, so I will go through their report first – comparing them to their prior results.

When they are out, the ANZ’s should appear here, the NAB ones may appear here (but I cannot be sure they will be explicitly linked as the NAB do not appear to be particularly clear about where they will go) and the CBA’s here, although, like the NAB, they do not appear to be completely sure about the location yet.

On to WBC, then. First thing to note, and a good one at that, is that they seem to be erring a little more on the side of putting more qualitative information out than in their previous, rather terse, report – not, mind you, that this is a model for open disclosure. The second thing to note is that the numbers are directly comparable, as the St. George prudential numbers (except for the capital ratios) are not actually in here. Presumably this is because the St. George Pillar III report will be issued seperately.

One other point to note is that I have taken the opportunity to correct a couple of small inconsistencies in my previous treatments out of the updated spreadsheet. The “Small Business” category is now consistently treated in the way the banks treat them – as retail loans, so they are now in the “Other Retail” category.

Last thing to note, before getting onto the numbers, is that Westpac seem to be doing well in their program to get more “Advanced” approvals for their book. The amount covered under their Standardised (with the exception of Specialised Lending, with they cannot until APRA allows it for all banks) is down from $10.4Bn to $6.6Bn. As they have not broken this out amongst the categories I cannot see where the improvements are, but this is good nonetheless. My guess is that this is in the “Other Retail” category, perhaps with the personal lending business now in the Advanced category, but this is just a guess.

The Numbers

The numbers are quite interesting. WBC has greatly reduced lending to governments, with more than half of that portfolio gone. This seems to be as a result of a massive sell-off of government bonds, as the major part of the drop has been in the “Market-related” section of the portfolio. My guess is that this is profit-taking in a reducing interest rate environment – but I cannot be sure as the results announcement makes no mention of it.

On the other hand, lending to other banks is massively up, with a halving of the holdings of other bank’s bands being overwhelmed by an increase in normal inter-bank lending from $2.9bn to $43.8bn. As the regulatory capital impact is minimal, this must have (nearly all) been lent to others of the Big 4. I await their reports to check on this. If theirs look similar then we may have a big money-go-round happening.

With the exception of residential lending (up 9% in a quarter), the rest of the business seems to be in gentle decline, with securitisation and credit cards (QRR) slightly down and other lending only slightly up.

Passt Due and Impaired

As has already been heavily trailed, the past due and impaired numbers are up and, in the case of corporate lending, heavily up. Many of the problem loans do not even seem to have gone overdue before being counted as “Impaired” as last the disclosures’ “Corporate” 90 dpd number was only $157m and the impaired number this time has gone up by nearly $700m – and some of the $513m reported last time should have been written off by now.

The rest of the movements are what could be expected at this point in the cycle, with the “Residential Mortgage” impaired number implying that something around 700 residential mortgages are likely to cause the bank some losses. In this market that is a good result and reflects the strength of the normal lending policies.


Overall, the capital numbers are largely unchanged, but there has been a significant shift to Tier One from Tier Two. Like the losses, this has been well trailed in the announcements and really needs no further comment.

I await the announcements from the other banks.


I received an email on this one – I missed one thing and need to correct another. The Sovereign and Bank numbers changes are explained on page 4 of the release – they have changed their EAD calculation methodology for these and it resulted in the numbers changing. As they note in the release, though, this has little impact on the actual capital numbers as neither of them receive much capital weight.

The correction is to my calculation of the Standardised portfolio. Previously, following a methodology for calculation where I have worked in the past, the “Other Assets” were thrown into the Standardised bucket. I will pull them out and do those seperately from now on.

I will incorporate this change into my analysis of future numbers from all the Banks.


Westpac’s Pillar 3 stuff is out and, unlike CBA, I can actually find them on their website – the pdf is here.

It looks like they have decided that their big disclosures will co-incide with their September year-end and half year (March), so this is the big one for the year. A bit of a pity, as it would have been nice to have the all the numbers out for each period actually corresponding across all the banks, but this is not to be.

I will be building up a spreadsheet as these come out for the ANZ and NAB over the next couple of days, but my first impressions of the Westpac ones are below.

Overall, the Westpac number come in as should be expected. Compared to the CBA numbers they reflect a slightly smaller portfolio with less capital but (slightly) more impairment in there. Of the two sets of numbers, CBA is obviously in the stronger capital position and it has a better portfolio. The numbers show that Westpac remains a strongly capitalised bank, though. Even without the government guarantee I would have little doubt as to its ability to survive and prosper. I hope so – my deposits are in there.

The other interesting point is just how similar the Basel II programs must have been. The Standardised / AIRB ratio of the portfolio are both just under 10%, so the amounts of assets that they have both managed to get recognised as AIRB qualified are about the same.

When I get some time I will run through all of their long form disclosures and see where the differences are. This should, if they have done it correctly, show up differences in how they manage risk. That said, I do not think APRA would tolerate a heck of a lot of differences in this area.

When I get the NAB and ANZ numbers I will do more, but this will have to do for the moment. Paying clients await.

Of course, if someone want to pay me to do a full analysis…

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