We’ve talked a lot about bank capital today but there’s still time for one quick addendum. First, though, two rough-and-ready equations:

  • Capital = cash paid in by shareholders plus retained earnings
  • Capital ratio = capital divided by assets

The first equation explains my puzzlement at the claim that Deutsche Bank “book[ed] a loss to boost its capital ratio without selling shares;” it’s arithmetically impossible to boost your capital by losing money, though you can (separately) boost your capital ratio by fiddling with the denominator.

The important thing about the second equation is that, for banks, the ratio is well under 1. So if your capital ratio is a relatively robust 10%, that means that 90% of your total assets are funded with borrowed money, and 10% are funded with cash from shareholders and retained earnings. Some people dislike this system.

Anyway there are various semi-magical ways to monkey with the denominator but there is one simple and obvious way to monkey with the numerator – the actual amount of capital that you have – and it is this:

  • Take some money,
  • dress it up in a fancy costume, and
  • issue some new shares to the the now-cleverly-disguised money.

You have magically transformed Assets (money) – which, remember, are 90%+ funded with borrowed money – into Capital. This has perpetual-motion-machine properties,1 so it’s pretty good.

Also it is, like, wildly wildly wildly illegal. Or, I mean, it’s pretty illegal as I just outlined it above, but if you put a fancy enough costume on the money maybe that makes it okay.2 Anyway draw your own conclusions about this:

UK authorities are probing an allegation that Barclays loaned Qatar money to invest in the bank as part of its cash call at the height of the financial crisis in 2008, which enabled the bank to avoid a UK government bailout.

While the terms of Barclays’ emergency fundraising have been under the scrutiny of the Financial Services Authority and the Serious Fraud Office since the summer – with a particular focus on fees paid for the deal – allegations over a loan to the Qataris is a new thread of the investigation. Two sources familiar with the situation have independently told the Financial Times of the investigation into the alleged loan

If confirmed, such an arrangement could contravene market regulations if it was not properly disclosed at the time, legal and industry experts warned. “The concept of lending money to any investor to purchase your own shares raises a series of immediate questions about disclosure and other regulatory issues,” said Peter Hahn, a former banker at Citi now at Cass Business School.

My conclusion is that if that’s true it’s kind of amazing. (Not unheard of, but still amazing.) It makes the rest of today’s bank capital gamesmanship look pretty trivial.

Barclays in Qatar loan probe [FT]

1. Because your cash comes back in the door when you get the capital investment. So you have more assets. [Not, like, for real, but in your magical perpetual-motion-machine's accounting.] So buy more capital. Etc.

2. Clearly legal examples welcome? Like one imagines regular-way ordinary-course margin loans, swaps, etc. on seasoned public stock don’t raise too many eyebrows?

Comments (7)

  1. Posted by Martinghoul | January 31, 2013 at 6:32 PM

    Why does this come as such a shock? This has been practiced by many other banks previously. For example, see here: http://www.ft.com/cms/s/0/6c89260a-fb29-11e0-8756

  2. Posted by [TBU] | January 31, 2013 at 8:49 PM

    At some level of security / collateral, this must be economically sound and merely liquidity management for for investors right?

  3. Posted by Anonhfm | January 31, 2013 at 9:16 PM

    Likewise with Kaupthing Bank, and even involved a supposed Qatari investor, too.

  4. Posted by NYC Banker | February 1, 2013 at 5:55 AM

    I agree with TBU… if the loan was secured by collateral other than the Barklay's investment and that collateral wasn't of the made-up-we-say-its-collateral-but-its-not-really-collateral genre, then I'm not sure this is a big deal. The prime brokerage units of large banks provide leverage to hedge funds for equity investing all the time…

  5. Posted by John | February 1, 2013 at 9:40 AM

    Likewise with Anglo-Irish lending to Sean Quinn et al.

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  7. Posted by sohbet | March 29, 2014 at 4:23 PM

    Likewise with Anglo-Irish lending to Sean Quinn et al.