I spent some time studying banks history earlier and perhaps not surprisingly, found that most bank crises stemmed from liquidity initially. It could be a bank run on deposit, spikes in short term rates or dried up of liquidity leading to suspension of the interbank market.
In fact, I believe the study of liquidity in the economy, that is for government, corporate and individuals, is paramount to understanding banks’ risks. Because liquidity shortage in one of these areas could imply rising risks for banks hence is an early indicator.
While I appreciate banks need to be capital sufficient, I also think a bank’s capital is not something it can immediately sell to address short term liquidity, a key reason for its failure.
If a bank has sufficient liquidity, it can always restructure and extend loan duration to stay in business (forever green loans).
Sharing a Professor Werner video below. Would recommend anyone interested in banks to study his work.
However, back in the days when I was a banks analyst, I spent a lot of time piling through annual reports, industry papers, news on credit quality trends.
There are a lot of focus on credit quality, non-performing loans, overdues.
When I had a short stint on the credit side, I also note that a bank’s rating is largely predicated on its asset risk, capital and profitability. While there is some focus on liquidity and funding, the weighting is not as high.
I think this has to do with the lack of data and information available, which is causing a disconnect for investors.
In a bank’s annual report, there is a lot of information, disclosures and breakdowns for credit quality, profitability, balance sheet but relatively limited on liquidity.
For the banks I used to cover, there is really just a few tables on liquidity coverage and maturity/duration of assets and liabilities. They are in the notes of the financial statements with no commentary. In fact, there is really just one metric, the liquidity coverage ratio that is directly related to liquidity.
These figures only represent a point in time and are disclosed half yearly or at most quarterly. If there are significant fluctuations in rates or short term liquidity, it is impossible to make an objective assessment of the actual financial being of the bank. Investors can only rely on the words of the banks’ management that stress testing and VaR were conducted.
I wonder with the recent rise in Fintech, if it is possible for banks to provide more dynamic disclosures. These can be more frequent (possibly real time) and interactive reports. Can technology help solve the issue of practicality and cost?
Disclaimer: This article is my personal opinion and does not constitute any investment advice.