MINISTRY OF EDUCATION AND TRAINING
FOREIGN TRADE UNIVERSITY HO CHI MINH CITY
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MONEY AND BANKING REPORT
TOPIC 3: BANKING
List of members:
1. Huỳnh Tấn Khôi (1501015236)
2. Nguyễn Xuân Thảo Ngân (1501015341)
3. Nguyễn Hữu Nguyên (1501015371)
4. Mã Tuấn Phong (1501015419)
Class: K54CLC4
Instructor: Nguyễn Thị Hoàng Anh
Ho Chi Minh City, April 10th, 2017
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Comment on the following argument:
“More equity might increase the stability of banks. At the same time, however,
it would restrict their ability to provide loans to the rest of the economy. This
reduces growth and has negative effects for all.”
Josef Ackermann, CEO of Deutsche Bank (November 20, 2009, interview)
Response
In retrospect, the period from 2007 to 2009 has witnessed one of the most tremendous
financial crisis since the Great Depression of the 1930s. In 2007, it began with the rise
of house price in the U.S.A, and developed into a global banking crisis when the
largest investment bank – Lehman Brothers failed to continue operating and collapsed
on September, 2008. The whole crisis can be summarized in the securitization food
chain that many financial institutions were involved in. The first step in the chain
began with the simple process of granting of mortgage loans to consumers at
commercial banks. For the lenders, mortgage notes were considered as assets, but
these assets clearly bore counterparty risk: the borrower could be unable to repay the
loan. The banks, encouraged by new capital ratio requirements from the U.S.
government and the Basel II Accord, sought ways to sell notes for cash. They decided
to repackage those loans into the form of collateralized debt obligations (CDOs) and
pass on the debt to the investment banks. This was the second link in the securitization
chain. This spread the risk of default around, similar to how standard portfolio
diversification works. Subsequently, the investment banks resold these CDOs to
people or mutual funds who want to invest on it. The investors would receive a
proportionate amount of the mortgage payments as a return on investment, this is the
last part of the chain. The whole system seemed to be operating well, but things started
to go wrong. Due to the steady increase of house price, commercial banks started to
make subprime mortgages, and the probability of failure involved in those lendings
became higher and higher. And to made those CDOs become more attractive to
investors, investment banks pay money to let the rating agencies to put high ratings on
those securities, while they started to buy credit default swaps (CDSs) for the
securities that they sold to investors. When the bursting of housing bubble happened,
the value of these derivatives plummeted, damaging financial institutions globally,
including banks. During this catastrophe, a great number of banks collapsed because
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they became illiquid when the crisis occurred. Almost all banks in the USA had
extremely low level of equity capital because of loose capital reserve requirement of
the banking system and many regulators aimed at raising the requirement to avoid
another crisis. However, the CEO of Deutsche Bank – a bank has survived through the
crisis claimed that: “More equity might increase the stability of banks. At the same
time, however, it would restrict their ability to provide loans to the rest of the
economy. This reduces growth and has negative effects for all.” In this paper, we will
provide a deep analysis about this statement.
Under an economist’s view, bank capital is the amount of equity with which a bank
chooses to finance itself. First of all, banks with large equity are more stable than the
ones who have the smaller equity, to some extent, it is correct. A bank with high level
of equity capital can reduce the risk of being insolvent and the probability of financial
distress as well as the bank failure and systemic risk. In fact, the lower the probability
of bank failure is, the greater the amount of time the bank’s managers have to sight
impending danger and make decisions that increase the bank’s odds of survival is.
