Inside the Banking Crisis, Too Big to Fail, and CAMELS
by Britney MayCom
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"Too Big to Fail"

This "Too Big to Fail" policy is an often used, and often abused, banking term to describe the tendency of bankers making bad loans with the underlying belief that a "lender of last resort," either the Federal Reserve or the International Monetary Fund will bail out under performing and failing banks. This bailout during the American money crisis is an attempt to keep banks within their required capital requirements.

With the capital to asset capital ratio of many banks in jeopardy, this raises the important question of regulating loan requirements, raising the national prime rate, and perhaps even keeping a more stringent capital ratio if the Fed believes there may be large future fluctuations in asset values.

The "moral hazard" associated with bailing out banks kept the US Fed from keeping Lehman Brothers Inc. from declaring bankruptcy protection midnight September 14, 2008.

Solidifying the Banking Infrastructure

With America on the brink of a major unwinding of mortgage holders, Collateralised Debt Obligations (CDO), and falling capital ratios there may be a trend toward more conservative banking practices.

CAMELS

Banks are rated on a one being best, and five being worst, scale to assess to what degree our financial institutions are going concerns.

Capital: Bloomberg reported average regulated bank capital ratios at 12.79% a dauntingly low number. This could mean less lending, regulated lending, and possibly an adjustment to leverage guidelines.

Assets: This metric is an obvious place of contention as billions in mortgage loans have lost 75% of their value.

We intend to see much more critical assessment of the quality of a money institution's assets.

Management: The quality of a bank's management is more important than ever. They must know the value of liquidating low value assets, spinning of divisions to shore up capital ratios, and keep a close watch on lending practices and the bottom line.

Earnings: With banks as large as JP Morgan and Wells Fargo showing lackluster earnings, it will take a creative incentive strategy, possibly including higher yields and bonds, to keep investors interested.

Liquidity: Large banks generally lack sufficient deposits to fund their business needs - when dealing with large companies, governments, other financial institutions, and wealthy individuals, they borrow the funds they need major lenders as short term liabilities which are continually rolled over. We may see more emphasis on assets and less emphasis on liquidity as capital ratios go lower.

Sensitivity to Market Risk: This is the risk that changes in market conditions could adversely impact earnings and capital. Expect ALCO reports to be monitored closely in 2008, 2009 and 2010.