Picture: THINKSTOCK
Picture: THINKSTOCK

THE banks just are not doing well, none of them, not even the ones that you still think are. Banking is, sort of, the central organ of the economic body.

When the banking system starts looking unwell, it’s often symptomatic of the state of health of the whole organism whose blood it filters. The economic blood of the system passes through the banks, and a lot of it used to stick — not so much any more. Banking has changed, banks can no longer operate above the realities of the economies that they facilitate.

Bank valuations are now, many would argue, very attractive. Historic dividend yields are high and market prices have fallen off dramatically — the S&P banking index has been down 25% for the year so far. All the big names are involved — Citicorp, Morgan Stanley, Deutsche Bank — the blue chips of global finance, the too-big-to-fails, the invincibles. We’re back to prices of the previous century, the previous millennium (yes, I know).

If someone had asked me to name the bluest of all blue chip banks in the world, I would not have hesitated in naming Deutsche Bank. I mean, even the simplicity of its logo exudes strength, security, confidence. The share price doesn’t think so. It is hard to keep up with the percentage moves up and down but suffice it to say that Deutsche Bank shares are trading at way less than half the price they were immediately prior to the 2008 financial crisis. That is not good.

As ever, in the midst of these devaluations, those stakeholders who are most affected are doing what they can to restore confidence. Deutsche Bank bought back $5.4bn of its debt (which was behind the 11% jump in their share price last week), which improved their capital ratio, which was well below its peers. JPMorgan Chase CEO Jamie Dimon just bought about $30m of JP Morgan stock, which made him about $2m profit. It is a bold gesture (even though he’s only risking one year’s package) and let’s hope it is based on sense, not bravado.

Other financial instruments will and have been developed to bet for and against these trends — contingent convertible bonds, credit default swaps, you name them. These are not cures, they are for the spectators, not the players, and they do not really affect the game.

The trouble is that today’s troubles only show in tomorrow’s balance sheets, for banks. It’s not the income statement that rules the waves for banks, it’s the balance sheet. I’ll repeat the model: 10% equity, and 90% deposits means that a 2% margin on assets gives you a 20% return on equity. That’s all very well depending on principally two things — interest rates should be "reasonable" and assets (loans, for banks) must retain their value. If not, a 10% markdown in loan values can wipe out years of margin. Neither of these two conditions are in place.

Interest rate impacts are measurable and visible almost immediately, but for asset values you have to wait for the next period of public reckoning to know, for sure. The extent of asset impairment always comes down to a judgment call — the numbers that the formulae produce are no more than a first cut at the answer. The inputs to the models move around so much now that the output number may need to be recalculated before the ink has even dried on the input assumptions.

If indeed the real economy is as bad as stock market and bond prices are suggesting, then some of that pain has to still come through the banking system. When will the geared equity positions trigger cover ratio covenants?

When will the first farm fire-sale reveal a true market price that can no longer be ignored for marking the whole mortgage loan book to market? When will the billionaire London property prices of recent times begin to fall mercilessly in sympathy with the fortunes of the oil and commodity barons that bought them? It is only a matter of time.

All of this is just catch-up for the ill-advised, monetary policy encouraged (couldn’t resist that plug) "assets at any price" environment that we’ve been living in since the notorious Lehman Brothers collapse and rescue, now approaching a decade ago, but still with us.

To be fair, credit assessment is difficult in such a volatile environment. How are you supposed to get to grips with the risk and still remain competitive in lending volumes when capital value change swamps yield? How are you supposed to second-guess the change and rate of change of exogenous variables in evaluating the merits of a five-year loan? Who would have called this oil price collapse five years ago? Who would’ve thought that the China growth story simply wasn’t all real? Who can prepare a life-of-mine valuation with any confidence?

Never mind that difficult stuff — tell me what the right discount rate is to apply in a discounted cash flow model. These are the things we need to know with a much higher degree of certainty in order to make capital investment decisions and fund them efficiently.

Uncertainty about present variables and future prospects in credit committee meetings gives the naysayers the floor. As much as easy money is not the solution, the absence of money isn’t either.

What to do about it all is a tough question. If we let banks fail, will that in and of itself collapse the already fragile economies of the world? If we let reckless lending be found out through failure, is that okay? With the benefit of hindsight, even some of the most thoroughly evaluated credit decisions may appear reckless, in the light of new information.

I have always come down on the side of less intervention after the event, but that necessarily needs to be coupled with a much tighter definition of what banks can do with depositors’ money.

A lot of the losses suffered by major banks over the past quarter have been in trading, not lending activities. As the attraction of simply lending out money reduces in current market conditions, so we should expect speculative activities to grow even more. Some banks will cut costs in time, some will change the way they do business, but most will just try to ride the cycle out, pay the fine, or double the risk or change the valuation policies. We’ll unlikely know which did what.

Dictating what should be done in a free market system is a contradiction in terms. Intervention in the self-righting mechanisms that capitalism inherently has to deal with greed and too much risk, leaves the circle incomplete. When bail-outs are an option, all risk trades are options.

We can’t let the financial system collapse. The solution to this all lies not in this detail, but in having the right long-term growth policies, and the time and leadership to implement them.

If the policy framework is clear and deliberate, banks will no doubt resume their rightful position in economic society, by matching the buyers and sellers of money, at the right price.

• Barnes is South African Post Office CEO