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: Read more »