Charting Banking XVIII: historic ROE and ROA

by PlanMaestro

How fast can a bank profitability recover after a deep recession? If the experience of the US at the end of the 80s (and Latin America 1982, Scandinavia 1992, Mexico 1994, Asia 1998, Argentina and Brazil 2000) is any guide, it can happen pretty fast. Japan is probably the only modern deposits-guaranteed exception to the rule  and we will get to discuss eventually Japan, that very misunderstood and important case – other possible exemptions are welcomed.

How can this be the case? The thing is that most banks while they are solving their issues they are still doing their business: pooling deposits to loan while earning a spread. The moment you end reserving for your past sins and you made it to the finish line with enough capital

  • deposits are still there
  • most assets are still there
  • most loans are still there
  • many competitors are not there

This does not mean that several banks will not go bust and capital should not be infused. After all bad loans were made and someone has to pay for them. But you can also pay them through the so called extend and pretend, that can work up to a certain extent if  assets are performing and your sins are not so bad. With a business that is still a going concern, 4 years of no returns (USA 1990) can pay for 10% of total assets going bad (assuming a conservative 50% recovery of bad loans and 1.2% ROA)

What is counter intuitive for many people is that banks in these bad harvest periods are also seeding  the good harvest years. Lot of competitors are out so banks are making the best loans ever and taking over these competitors deposits.

The risks of investing in banks are very high when bank hot money chases yield, lower  their standards and the costs of those overstretched loans are unknown. That is not what is happening today.