The Banking Crisis Continues

The banking crisis has not gone away, but is still with us. Banks have thinly disguised their shortcomings. They are still diseased, even though they have the appearance of modest health. Regulators, at the behest of governments, are trying to cure the patient without killing it. Whether they will succeed remains to be seen. Regulators are prescribing unpleasant medicine which will prevent banks from being as profitable as they once were, in order to try and reduce the risk of bank failure, which is catastrophic not just for the banks and their shareholders, but also for society.

The latest confirmation that the banking crisis is still with us is shown in Barclays Bank being required by the regulator to raise £12.8 billion in capital. It plans to sell shares for £5.8 billion and issue bonds for another £2 billion and undertake other measures which it will hope will bring its leverage ratio up to 3%. In the Alice in Wonderland world of banking the new regulator have required banks to hold at least 3% capital of their lending. In other words, if I set up a very small bank and lend £100, I would need to maintain £3 as capital in order to satisfy the regulator.
This shows why banks are so profitable and how they leverage deposits to lend much more than they hold. This also shows why banking is a very risky business and why depositing money with banks is also a very risky business.

Part of Barclays’ problems, which it shares with its competitors, is that it has indulged in dishonest practices of selling payment protection insurance to those that did not need it or did not want it or could not claim on it, and it has sold swaps and derivatives to small businesses that did not want them, did not need them and did not understand them.

In Barclays’ case they sold some customers swaps without informing the customer of all the terms and conditions of the Swap. The customers were small businesses, often borrowing less than one million usually for business activities in the United Kingdom with no need to enter into currency hedges or derivatives. In some cases the swaps were sold pursuant to the International Swaps and Derivatives Master Agreement. You can see what this agreement looks like at http://assets.isda.org/media/e0f39375/d851831a.pdf/ but unless you have a degree in law or are experienced in banking and then have a day or two to plough through the agreement, I do not recommend that you read it out of mere curiosity.

The document is very poorly drafted and it recently took the Court of Appeal to decide what “close out” means under the ISDA master Agreement. Even then, the Court’s judgment was not an epitome of clarity (you could scarcely expect it to be when dealing with derivatives) and did not accord with what the market expected.

Perhaps we should not blame the bankers for selling something which their customers did not understand; perhaps we should blame the customers. Bankers were, when these swaps were sold, held in high regard by their customers. The customers had got into a habit of believing that the interests of the bank coincided with the interests of the customers, as this had appeared to be the case for many decades previously. In fact customers failed to recognise that bankers had re-adopted a ruthless attitude to customers, who were seen as marks to be fleeced. The banks had no interest in keeping their customers solvent; indeed the banks preferred to fleece the customer, rather than to build long term relationships. Like buses, there would always be another customer along in a few minutes.

This attitude came from those sections of the banks that traded derivatives; they were trading with other banks and hedge funds in a dog eat dog environment, but this methodology was applied to the banks’ retail customers who had assumed that they were dealing with reputable straightforward and honest businesses. In fact retail customers were dealing with thieves.

I am explaining matters simply. Selling a derivative to a retail customer that does not want it or understand it or need it is not exactly theft in the technical legal meaning of the word, but most simple souls would regard it as theft and the best way to understand what happened is to simplify it, until you reach the essence; the essence was that the banks stole from their customers.

Of course, a bank can steal from all of your customers some to the time and some of your customers all of the time but a bank cannot steal from all of its customers all of the time and eventually the extent of its practices come to light and the bank that has indulged has to repay what it has stolen.

Not every penny stolen can be repaid; some businesses have closed and others are not aware of what has happened, but nevertheless the sums that the banks have to repay are large.

In the case of Barclays Bank, it will have to repay or is in the process of repaying nearly £2 billion of its gains ill gotten by selling derivatives and payment protection insurance.

Now Barclays is asking people to invest in it. I do not know whether that investment will prove to be a good investment or a bad investment, but investors must inevitably have the suspicion that something else might crawl out of the woodwork and Barclays will have to reassure them that this is not the case.

Meanwhile the regulator continues with the cure in the hope that the unpleasant medicine will cure the patient rather than kill it.

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