Has the US banking system really been “fixed”?

This excellent post by spontaneous finance (SF) is about the absurdity of current (and future) banking regulation rules. Spontaneous finance has some excellent posts on this topic and I recommend them all.

However, I do not want to talk about the topic of the post, but about the table at the bottom of the article because I think it has a big effect on market participants’ perception of the problems of the Eurozone.


It shows the “risk weighted assets” (RWA) as percentage of total assets for various global banks. As you can see, US banks use much higher risk weights than their European counterparts, i.e. they seem much more conservative. Given that – as a consequence of nonsensical regulation – banks have a lot of leeway in assessing RWAs the market thinks that European banks have some issues – otherwise they would not play with the numbers (models). Conversely, US banks look as if they can afford higher weights and therefore the market basically assumes US banking problems have been “fixed” (by the fed).

Now, I do not want to dispute the core assumption that European banks try to hide behind favourable self-assessments – they probably have to. I also agree that some of those US banks listed in the table (notably Wells Fargo, one of Warren Buffet’s main investments) indeed look fine. But I think it is wrong to deduce from this that the US banking system as a whole is much healthier than Europe’s, something we hear day in and day out from people who use the alleged health of the US banking system as a proof that the solution of Europe’s problems is the “United states of Europe,” i.e. more competences to the ECB or any other central authority.

My thesis rests on two simple arguments:

  1. Bank balance sheets of US and EU banks are not comparable without adjustments
  2. More importantly: the mortgage market in the US is outside the (private) banking system

Ad 1.)

As SF mentions, there is a big difference between IFRS (used by European banks) and US-GAAP when it comes to the treatment of derivatives. Whereas US-GAAP allows for netting of derivative liabilities and assets, IFRS requires them to be stated gross on both sides of the balance sheet. This matters especially for banks with huge investment banking operations, such as UBS or Deutsche Bank (DB) which, presumably for this reason, also rank at the bottom of the table above. In the case of DB, for instance, the difference amounted to 30 percent of their total assets at the end of Q3 implying that their RWA/total assets ratio would have been some 40 percent higher, had DB reported under US-GAAP.

But still, even if we adjust European banks’ ratios accordingly, US banks seem to have significantly higher ratios. Why?


I think the main reason why US banks look better has to do with the fact that European banks also hold mortgages on their balance sheet, whereas in the US mortgages are mainly underwritten by state agencies (Fannie and Freddy) that are usually not included in US commercial banking sector analysis. And mortgages have very low risk weights. Funnily enough, I could not find the risk weighted assets for Fannie and Freddie (I gave up after half an hour) on their IR pages to compare them to their overall assets (this alone makes me suspicious, maybe somebody familiar with the US banking system could provide me the figure). To illustrate: these monsters, both significantly larger than DB, have had negative equity until recently and total assets to equity ratio well over 50x suggesting that they are very thinly capitalized. And still a potential problem, if you ask me.

In my view,  the fact that they repaid the money received during the financial crisis proves nothing, as I can only imagine the tremendous political pressure exerted on management and regulators to repay tax-payer money. Politicians like success stories (and probably to show Europeans how “it is done”). Given these incentives, it is likely that dividends were paid out of capital.


When comparing the health of the US and European financial system (and, hence, assess the likely path of monetary policy), it is not enough to just look at private commercial bank statistics, as is usually done. This is due to the differences in mortgage markets explained above. Just comparing commercial bank balance sheets would suggest that EU banks are less conservative in their use of internal risk models. This is legitimate when comparing individual banks, but leads to nonsensical conclusions when talking about the financial system overall. Without including Fannie and Freddie, no statements about the US banking system can be made, especially after the experiences of 08/09. These are not risk-less entities and have a tremendous effect on the system. If anything, the fact that they are controlled by government probably means they are more risky. I find it puzzling that nobody seems to care about them anymore.

Including Fannie and Freddie’s assets (and their sliver of equity) in the analysis would probably show that the US financial system is as little fixed as the Euro banking system. Maybe that’s the reason why the fed has been accommodative for so long?


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