Monday, December 14, 2009

A capital question

imageRBA Governor and occasional Chaser’s War stand-in Glen Stevens had this pearl of wisdom to share re the GFC:

The intention, after all, is that lenders will operate with more capital against the risks they are taking. But capital is not free; shareholders have to be induced to supply it, and it will have to be paid for. High-quality liquid assets typically carry lower yields too, so mandating higher liquidity will have some (modest) cost as well. Admittedly it can be argued that shareholders of financial institutions will have a less risky investment and so should be prepared to accept lower returns.

My question is, if investors are already expecting insane returns on capital invested in banks, will this change anything or will it simply put more pressure on banks to produce the same returns on a bigger capital base?  See here for the historical data. The bottom line is that in the 11 years to 2008 the big 4 banks had an average ROE of 18.4% compared with yields on 10-year Government bonds of 5.8%.  Just how risky are these things?

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