New ways of looking at an old enemy

By Ayesha Sabavala

Cash, cash and more cash. Bank’s have been battling this enemy since the beginning of the credit crunch last year. Stress tests carried out by the US government reveal that ten of the nineteen top banks in the US will need to raise an additional $74.6bn in capital. The news was well received by the market as the shortfall was not as high as expected.

However, let’s take a closer look at how most of the bank’s are going to come up with this additional money. Bank of America, which needs the largest capital infusion of almost $34 billion will exchange government-owned preferred shares for common stock.  Most other banks are also using the same strategy.

How does this account for “additional” capital? Granted that this will enable banks to avoid paying costly dividends, which reduce earnings but the “conversion” will not inject the much needed cash these banks are looking for. Furthermore, US taxpayers should be worried as the government will now become a major shareholder in most of these banks, but at the bottom of the ladder.

What do I mean by this? Well, common stock holders are the last to get paid if the banks become insolvent. Therefore, some might say that the money paid to bail out the banks is now completely free for them as it does not even carry the cost of dividends. In addition, the government is now well and truly a major decision maker in the day to day running of these banks and I have said this before and I will say it again, “Leave the business of banking to the bankers.”

Banks must be pressured to improve their business models and get rid of unprofitable businesses. This is the only way depositors will begin depositing more money with banks and banks will start lending responsibly (under strict regulation and KYC compliance), thereby kickstarting the economy again.

The banking arena must become one in which only the fittest survive.  Allowing the weaker banks to fail might worsen the situation in the short term but in the long term, it will seperate the weak from the strong and create a more robust environment for investment.