Why Large Bank Safety is Really a Government Put

Global Finance recently came out with its 50 safest global and regional banks. It was basically a list of which banks had the highest credit rating from Fitch, Moody’s and S&P.

When I looked at the North America list, I found it interesting that Canada had six of the top seven banks. The top U.S. bank was AgriBank in the No. 4 spot, followed by CoBank in the No. 8 spot. (Yes, two banks backed by the Farm Credit System.)

So think about Canadian banks for a moment, which have been touted as some of the safest in the world. First, Canada is a resource-based economy that continues to face huge challenges. Second, its consumer housing market enriches banks but puts households in great debt. Canada has some of the world’s most unaffordable cities (e.g., Vancouver, Toronto) as measured by the ratio of income to housing prices. Vancouver’s real estate is the third most unaffordable.

One Canadian banker commented that diversification to Asia is not as fast as hoped, and Peter Hall, chief economist for Export Development Canada, said “our own investment constraints might be our worst enemy.”

What the "world's safest banks" really means is which governments are in the best position to bail out the banks come the next crisis. Because given negative interest rates, central government intervention in many markets, slow world growth and deflation, it is a good bet a bailout will be needed. It’s anyone’s guess how it will manifest.

Today, everything is a put on the governments around the world — everybody wants to believe in a free market — but government influences and ultimately controls markets. Why? Because left to our own devices, the financial crisis of 2008 would be a periodic event. This is where looking up the definition of moral hazard is relevant. With most places replete with moral hazard, everything is a put back to the government.

The second issue is that Canadian banks are interconnected to other banks globally. So if Citibank has problems, don’t you think Royal Bank or CIBC will have a huge exposure? Without fully understanding this exposure on their balance sheets — and I have found no so called “expert” that can untangle a bank’s balance sheet accounting outside of ratio analysis — we just don’t know.

So this leads to "safe" being defined according to our traditional measures — Moodys, S&P and Fitch. The reality is rating agencies are not highly valued or insightful, but they are still very important. They continue to be the only game in town.

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