Sunday, April 21, 2013

Why the hurry to "fix" Slovenia's banking system when doing it right takes time?

A Reuters article on eurozone leaders pushing Slovenia to fix its banking raises an interesting question: why does it have to be done quickly when doing it right takes time?

Common sense says that there are three steps to fixing the banking system the right way:
  1. Require the banks to provide on-going transparency so that market participants can assess their global asset, liability and off-balance sheet exposure details.
  2. Based on this assessment, the true extent of the problem can be determined and the losses can be realized.
  3. Determine how to rebuild the banks' book capital levels over the next several years.
It is common sense that transparency is needed so that there is no doubt that all of the bad debt hidden on and off the banks' balance sheets is recognized.

As Ireland, Greece, Portugal and Spain have shown, so long as the banks remain "black boxes", market participants will never believe that all the hidden bad debt hidden been recognized.

So long as there is this doubt about what is lurking on or off bank balance sheets, the banking system has not been truly fixed.

Putting ultra transparency in place takes time.

It is common sense that before fixing the banks, the true extent of their bad debt needs to be known.  It is only when the size of the problem is known that the solution for fixing the banks that corresponds to the size of the problem can be chosen.

It will take time for market participants to assess the value of each of the banks' exposures.

Finally, it is common sense that the banks do not need to be recapitalized immediately.  Savers and SMEs, who represent the banks' core depositors, are using the banks today even though they know the banks probably have low or negative book capital levels when adjusted for all the hidden losses on and off their balance sheets.

Recognizing the hidden losses and putting the banks on a path towards recapitalization is not going to make the savers and SMEs stop using the banks.  If anything, it should make them more comfortable using the banks.

Recapitalizing the banks through retention of future bank earnings takes time.

So, why the hurry?

No comments: