January 16, 2021

High & Low Finance: New Rules Will Give a Truer Picture of Banks’ Size

But it is not.

Under American accounting rules, banks that trade a lot of derivatives can keep literally trillions of dollars in assets and liabilities off their balance sheets. Since 2009, they have at least been required to make disclosures about how large those amounts are, but the disclosures leave out some things and — amazingly enough — in some cases do not seem to add up.

The international accounting rules are different. They also allow some assets to vanish, but not nearly as many. As a result, it is virtually impossible to confidently declare how a particular European bank compares in size with an American bank.

Much of that will change when first-quarter financial statements start coming off the printing presses in a few weeks. For the first time, European and American banks are supposed to have comparable disclosures regarding assets. Their balance sheets will still be radically different, but for those who care, the comparison will be possible.

This comes to mind because these days it seems that big banks do not much want to be thought of that way. A rather angry argument has broken out regarding whether “too big to fail” institutions get what amounts to a subsidy from investor confidence that no matter what else happens, they would not be allowed to fail. The banks deny it all. Subsidy? Penalty is more like it, they say.

We’ll get back to that argument in a moment. But first, there is some evidence that the big American banks may have scaled back their derivatives positions last year. At five of six major financial institutions, the amount of assets kept off the balance sheet appears to be lower at the end of 2012 than it was a year earlier.

Still, the numbers are big. JPMorgan Chase, the biggest American institution, had $2.4 trillion in assets on its balance sheet at the end of 2012. But it has derivatives with a market value of an additional $1.5 trillion that it does not show on its balance sheet, down from $1.7 trillion a year earlier.

So is JPMorgan getting bigger? Measured by assets on the balance sheet, the answer is yes. That total was up $93 billion from 2011. But after adjusting for the hidden assets, the bank appears to have shrunk by $109 billion last year. If the bank used international accounting rules, it appears it would be getting smaller.

Not having those assets on the balance sheet makes the bank look less leveraged than it might otherwise appear to be. If you simply compare the book value of the bank with its assets, it appears it has $11.56 in assets for every dollar in equity. Add in those derivatives, and the figure leaps to $18.95.

It is not as if those assets are not real, or that they are perfectly offset by liabilities also kept off the balance sheet. There is a similar amount of liabilities that are not shown, but there is no way to know just how they match up with the assets in terms of riskiness. The nature of derivatives makes it hard to assess aggregate totals.

If a bank has a $1 million loan to someone, that is an asset that would go on the balance sheet at $1 million. Presumably the worst that could happen is that the bank would lose the entire amount. But a large derivative position might currently have a market value of $1 million, and thus would be shown as being worth the same amount, whether on or off the balance sheet. But if the market moves sharply, the profit or loss could be many multiples of that figure.

Under American accounting rules, banks that deal in derivatives can net out most of their exposure by offsetting the assets against the liabilities. They do this based not on the nature of the asset or liability, but on the identity of the institution on the other side of the trade — the counterparty, in market lingo.

The logic of this has to do with what would happen in a bankruptcy. What are called “netting agreements” allow only the net value to be claimed in case of a failure. So the bank shows the sum of those net positions with each party.

Floyd Norris comments on

finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/03/15/business/new-rules-will-give-a-truer-picture-of-banks-size.html?partner=rss&emc=rss