Why Your Bank Is Broke

Paul Havard talks on his cell phone inside a Citibank branch in New York on Jan. 16, 2009

JB Reed / Bloomberg News / Landov

Even without doing the math, you probably get that the government's financial-rescue effort is failing. The signs are hard to miss. Your friend in finance got pink-slipped. A house sale down the street fell through because the buyer couldn't get a mortgage. A local bank is closing a nearby branch or maybe shutting down altogether.
But do the math, and you can begin to understand how really botched this bailout has been. Since October, the government has deposited $165 billion into the accounts of the nation's eight largest banks. Yet those same financial firms are now worth $418 billion less than they were four months ago, and the Congressional Budget Office estimates that the government's preferred shares are worth at least $20 billion less. In Wall Street terms, that's throwing good money after bad. All told, the government's annualized rate of return on its investment in the nation's largest banks is -1,096%. That's well beyond Bernie Madoff territory; he topped out at a mere -100%. (See pictures of the demise of Bernie Madoff.)
So how could $438 billion — $418 billion of their money and $20 billion of ours — go poof, just like that? Here's the easiest explanation: our banking system has sprung a leak.
Financial firms are built on capital. They take in a dollar, borrow against it and then lend out $3, $4 or $9. Or $30. In the past few years, executives have been using thinner and thinner capital — acquisitions and questionable off-balance-sheet arrangements — to build their money pails. In good times, the more of those cheap sources of capital you use, the more profitable your bank will be.
For the past few decades, banks have been piling up risk, making more and more loans based on less and less capital. Years of economic growth, shallow recessions and record-low default rates lulled bankers into thinking that the future would resemble the immediate past, at least as far as risk went. Turns out it didn't. All it was going to take was a worse-than-average recession — and it looks as though we've got one — and many banks, including a number of the biggest ones, were bound to fail. The shockingly poor lending standards — housekeepers being approved for million-dollar mortgages — have only hastened their demise. "This crisis needs to be understood as something that has developed over the past decade," says Joseph Mason, a finance professor at Louisiana State University's E.J. Ourso College of Business. "This isn't just one black swan. It's a bunch of black swans that have hung out for a while and created a giant problem." (Read George W. Bush's top 10 economic mistakes.)
There's little hope that the type of shares the government is buying in banks as part of the Troubled Asset Relief Program (TARP) will plug the hole in the banking system's bucket. Paul Miller, an analyst at FBR Capital Markets who has written a number of reports on the capital issues of banks, says the only way to solve the problem is for the government to stop buying preferred shares and start taking direct ownership stakes. Of course, the issue with that approach is that the problem at the banks is so large, Uncle Sam may end up owning a good portion of the banking sector. Few seem to want nationalization. Unfortunately, that could be the only way out.

Standard Chartered overhauls board

Standard Chartered, the international bank, overhauled its board today and promised to separate its risk and audit committees next year in an attempt to "improve corporate governance", as demanded by the Walker report on banking, published last month.
The bank, one of those most severely exposed to the Dubai financial crisis, has appointed three new non-executive directors, Dr Han Seung-Soo, a former prime minister of South Korea, Simon Lowth, chief financial officer of AstraZeneca, the pharmaceutical company, and Richard Delbridge, a dyed-in-the-wool banker who previously held roles with HSBC, Natwest, and Midland Bank.
Standard Chartered signalled the start of a fresh approach to risk as Gareth Bullock, the group executive director responsible for risk, decided to retire after a 13-year career in the bank.
Richard Meddings, group finance director, takes over responsibility for risk at an executive level.
The bank said that its chief risk officer, Richard Goulding, would report to both Mr Meddings and the board's risk committee.
John Peace, chairman of Standard Chartered, said "Strong corporate governance is essential for delivering sustainable shareholder value ... I am pleased to say that these changes are in line with the Walker Report recommendations."
The bank confirmed the appointment of Rudy Markham as senior independent director and Jaspal Bindra, Standard Chartered's Asian chief executive, as the group executive director, keeping his responsibilities for the Asian market.
Mr Peace said: "We are adding significant financial and banking experience to the board, as well as increasing its diversity to include members with special insight from our key Asian markets."
Standard Chartered also said that it would "significantly enhance" its sustainability and responsibility committee to review risks to the bank's reputation and brand, culture and values and "ethical and social legitimacy" and whether it treated its customers fairly.

Bank of America’s TARP Move Helps Shed Stigma

Less than a year after grasping two multibillion-dollar bailouts from Washington, a resurgent Bank of America announced on Wednesday that it would repay all of its federal aid, underscoring the banking industry’s swift recovery from the gravest financial crisis since the Depression.
Despite continuing problems with its loans to struggling homeowners and consumers, Bank of America plans to return the $45 billion in aid that it received at the height of the financial panic — a step that, only months ago, would have been almost unimaginable, Louis Story writes in The New York Times.
But like many other big banks, Bank of America is once again making money, in large part through Wall Street businesses like trading stocks and bonds, rather than by making loans. Its recovery, while many ordinary Americans are still struggling, is an important milestone in the government’s yearlong effort to stabilize the nation’s financial industry.
The Obama administration has begun talks with lawmakers about using unspent money from the financial bailout program to help offset the costs of spending to create jobs.
For Bank of America and its beleaguered leader, Kenneth D. Lewis, the turnabout is particularly sweet. Mr. Lewis was driven first from his role as chairman and then from his post as chief executive after the bank’s controversial takeover of Merrill Lynch last year. Now, with only weeks remaining in his tenure, he has managed to extricate Bank of America — not long ago regarded as one of the nation’s most troubled big banks — from Washington’s grip.
Wednesday’s announcement followed months of heated negotiations between the bank’s board members, executives and federal regulators. It is a particularly delicate time for Bank of America, which has struggled to find a replacement for Mr. Lewis. By paying back the money that it received under the Troubled Asset Relief Program, or TARP, Bank of America will free itself from exceptional federal oversight of its executives’ pay — a thorny issue in recruiting a new chief executive.
Indeed, Bank of America’s board has been riven by dissent over just who should lead the bank into its post-bailout period. Several potential candidates have said they were not interested in the job, in part because of the bank’s federal bailouts and the strings attached to them.
But by paying back its rescue funds, Bank of America will shed much of the stigma associated with financial companies that received not one but two federal bailouts. Its repayment will leave Citigroup and GMAC standing alone as the only giant banks that have received such extraordinary aid, although other banks big and small have yet to repay single bailouts.
Bank of America will repay part of its relief funds by selling $18.8 billion in stock that is expected to be converted into common stock, a move that will further dilute its existing shares even as it strengthens the bank’s financial footing.
But most of the money will come from money that Bank of America has generated in recent months with its wagers in the financial markets. After its acquisition of Merrill — a takeover that was once panned but now appears to be paying off — Bank of America has taken greater risks to compete with Wall Street giants like Goldman Sachs and JPMorgan Chase.
The bank said it would put $26.2 billion of its cash toward repaying its bailout and would also sell off $4 billion in assets.
Mr. Lewis was criticized for paying too much for Merrill Lynch, whose gaping losses prompted Bank of America to seek a second lifeline from Washington. The events surrounding the takeover, and the government’s role in it, remain highly controversial. Some shareholders contend that Bank of America failed to disclose adequately the risks associated with the deal, which remains under state and federal scrutiny.
A Treasury Department spokesman said the bank’s repayment represented a major step in removing the government from the banking sector.
“As banks replace Treasury investments with private capital, confidence in the financial system increases, taxpayers are made whole, and government’s unprecedented involvement in the private sector lessens,” said Andrew Williams, a spokesman for the Treasury.
The months-long struggle between the bank and regulators focused on the amount of capital that Bank of America would have to raise to repay the bailout funds. Regulators are pushing major banks to increase their common equity, and the decision about Bank of America’s financial makeup raises questions about whether regulators will demand increases at other banks like Wells Fargo.
Now Bank of America’s board will focus on appointing Mr. Lewis’s successor, a process that began in October when he surprised even close associates by saying he would retire early. The board plans to meet in Charlotte early next week and hopes to interview a few of the final candidates.
Once the bailout money is repaid, the bank will no longer have to consult with the Treasury’s special master of compensation about what it awards its new chief executive, or any other employee. That may open doors for outside candidates for the job who were wary of accepting a job under the government’s thumb.
Bank of America executives have insisted for months that the bank’s underlying businesses were far stronger than those of some other banks and that the Merrill merger would pay off quickly. Indeed, Merrill’s businesses have improved this year as Wall Street’s traditional business of trading and deal making picked up. At the same time, Bank of America’s core consumer lending units suffered greater losses as the economy weakened.
The bank’s negotiations with the government were led by Greg Curl, who took over as its chief risk officer in June. Mr. Curl negotiated the bank’s merger with Merrill last year, and he has been considered a potential successor to Mr. Lewis.

Traditional banking activities

Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and ATM.
Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.

Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account.
Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to

Bank of Indiana

The state Bank of Indiana was a government chartered banking institution established in 1833 in response to the state's shortage of capital caused by the closure of the Second Bank of the United States by the administration of President Andrew Jackson.

The bank operated for twenty six years and allowed the state to finance its internal improvements, stabilized the state's currency problems, and encouraged greater private economic growth. The bank closed in 1859. The profits were then split between the shareholders, allowing depositors to exchange their bank notes for federal notes, and the bank's buildings and infrastructure were sold and reincorporated as the privately owned Second Bank of Indiana

Case study 2 – Sudden increase in turnover

Lets examine the following reported turnover of my client :

F/Y 2008 – RM 13 mil.
F/Y 2007 – RM 10 mil.
F/Y 2006 – RM 9 mil.

From the surface of the above figures, it shouldn’t be too much of problem if this client wants to apply for additional facility based on the F/Y 2008 increased turnover.

 

However, after examining the last 12 months bank statements, I noticed that the average monthly deposit is only RM800k+, meaning the turnover for F/Y 2009 is anticipated to come down to its previous years’ average of RM10 mil. On further questioning on the F/Y 2008 result, the client admitted that there was 2 ad-hoc transactions during the financial year which had pushed up the turnover and such transactions are not foreseen to be recurring in future, meaning these were just one-time transactions.http://www.springerlink.com/content/dgty5hl041cjhc12/ In this scenario, bank will only evaluate the working capital requirement of the company base on the projected turnover of F/Y 2009 and not F/Y 2008.

If the bank offer me business loan, should I take it ?

Sometimes bank will approach SME business and offer a small loan for their business when they do not need this money, the business owner will start asking whether they should take it. Here’s are my advice.
Take it :

1. 
   
   

   If this loan can helps you to generate additional business. Make sure the profit is sufficient to cover the interest and other associated costs (legal fee, and stamp duty, CGC guarantee fee).

   
   
   
2. 
   
   

   If the interest rate of this loan is lower than any of your existing facility so that you can have some savings from using less of your existing facility.

   
   
   
3. 
   
   

   If you foresee that you may need the money in near future to finance your increasing sales or anticipated new contracts.

   
   

   Do not take it :
   

1. 
   
   

   If you do not know what to do with the money for time being and do not foresee any new business or contracts coming. Normally there is a fixed cost associated with this loan, eg. legal fee and stamp duty, and CGC guarantee fee. I do have clients who took up bank facility but did not in any way increase its turnover and the these costs eat into his profit.

   
   
   
2. 
   
   

   If you intend to use the money for a new business which is not related to your existing business or do not complement your existing business.

   
   
   
3. 
   
   

   If you intend to keep the money for personal use.

   http://www.businessweek.com/the_thread/hotproperty/archives/2007/03/the_new_exit_st.html
   
   

Some business owners regretted for not accepting the loan when their subsequent application was rejected by banks especially when the business environment gets tougher. In fact, they should be happy that the loan was not taken up since it is more difficult to make money now to repay the loan.