November 28, 2011

Santiago, Chile

If the global financial crisis has taught the world anything, it’s that there is massive weakness running through western banking systems.

The big banks in New York and London, once considered to be the strongest and most stable in the world, have been completely exposed for what they are– weak, toxic, and corrupt.

Between subprime debt, shaky sovereign bonds, and uncertain consumer loans, most of these banks are sitting on incalculable losses. They get around disclosing their true financial condition by using clever accounting tricks (which are completely legal thanks to government regulators).

As such, they can go on borrowing money from the Federal Reserve at 0% and loaning it to the US government at 2%– a practice that has essentially become the banks’ core business.

If you haven’t noticed, most banks hardly lend against anything that isn’t guaranteed by the government anymore. A Fannie Mae conforming loan is a no-brainer, but making a small business loan is a non-starter.

By way of personal experience, one company that I co-own is a very successful retail products brand. We went to the bank to obtain a loan to buy more inventory, secured by accounts receivables and contracts from mass retailers (think Wal Mart and Target).

And yet, no bank would finance us, even with our strong revenues, brand success, documented future cash flows, and excellent credit. The only loan they would grant had to be matched and secured by cash. In other words, they would happily loan $1 million… as long as we deposited $1 million in cash as collateral.

This is hardly a well-functioning system… let alone the pinnacle of global banking.

I’ve long pounded the table on banking overseas– foreign banks are often healthier, more innovative, more secure… and best of all, not controlled by your home government.

You may be surprised, for example, to learn that, according to recent FT data, the country with the most profitable banking sector (as a percentage of average capital) is none other than… Pakistan! The country’s banks posted an average profit of 36.41% of capital. Brazil, Indonesia, and Egypt rounded out the top 4, all exceeding 30%.

(Australia and Canada were the only big western nations in the top 25 at roughly 20% each.)

In terms of regional profitability, Latin American banks lead the world with an average return on capital of 27.09%. This is more than twice as high as North American banks (11.16%) and European banks (8.5%).

Real profits certainly count for something; banks that are legitimately profitable are healthier, and healthier banks are safer for depositors. In this day and age, bank safety is paramount.

I’ve often cited the fact that certain places like Singapore have never had a bank fail, ever, partly due to the high capitalization levels. This is a key measure of bank safety– and some of the top jurisdictions in the world (as measured by stricter tier 2 capitalization levels) are Israel, Chile, Colombia, and Hong Kong.

By way of comparison, the US, UK, Canada, etc. are nowhere to be seen in the top-20 for this category.

One of my preferred metrics for bank safety, however, is the loan-to-deposit ratio. For example, if a bank has $100 million in deposits, and their loan portfolio amounts to $95 million, then the loan to deposit ratio is 95%.

Clearly, the lower this ratio, the better; a safe bank has a lot of cash on hand and loans out funds judiciously.

Banking jurisdictions with some of the lowest loan-to-deposit ratios (i.e. the safer places) include Lebanon, the Philippines, Hong Kong, and Andorra. Places with the highest ratios (i.e. the riskiest) include old favorites like Italy, Ireland, Portugal, and Sweden.

With banking systems (and governments) collapsing all around us and the very nature of fiat currency being called into question, it’s important that people no longer ‘assume away’ things like bank safety.

Just because a bank has been around for a hundred years doesn’t mean it can’t collapse. Just because there’s a government guarantee doesn’t mean the whole system can’t collapse… including the government itself.