How Can I Sign Missouri Banking Presentation

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you so we have this problem of historical problem in the United States a banks failing and individual banks failing and that leading to sometimes a bank run and then a larger problem of Bank panics we've talked about some of the attempted solutions we got the lender of last resort that was the Federal Reserve's responsibility and didn't work out very well when the Federal Reserve wouldn't lend to the discount window we talked about how the FDIC was created and that did turn out to be effective at stopping bank runs and panics okay there are a number of regulations that we talked about several those regulations I mentioned Chardon regulations and so forth that would and I sort of grouped those together I think I talked about four different regulations that not only were they regulations that would reduce the number of bank failures but they would do so by adding to profits of banks and banks like those kinds of regulations I'll mention a couple of other kinds of regulations and then we'll go on one regulation limitation on Bank assets these are not always something that you know I'm sort of grouping I've already talked about various types of Bank regulations capital requirements and regulation q and things like that and those I sort of put as a group because they contribute to bank profits these are just some more Bank regulations that we can't really describe them that way here's a couple of examples no corporate stocks no junk bonds we don't want banks taking risky investments with depositor money okay now banks sometimes do buy corporate stocks through the trust Department where they like if you come to them and they are managing your money not your deposit but just your assets your net worth and they are money managers in that sense they will manage your money and buy stocks if you put that within their charter of what you want them to but that does not bankers using depositor funds or insured funds and so anyway that and that's what I'm talking about here is they can't buy corporate stocks they cannot buy junk bonds and there are other types so you know they can't just go out and start speculating on diamonds or things like this and and so anyway banks are limited to what they can do and there are also limits on the size of the loan to any one borrower they don't want a bank let's say we talked about roughly two-thirds sixty five percent or so of total assets are loans they don't want the bank just making all the loans to one borrower because then if that borrower gets in trouble then the the bank would have lots of loan losses and that would put it out of business and so what there would be is a limit on how much you can lend to anyone borrow so diversify the risk so these are things that banks don't necessarily like these are Bank regulations to reduce the likelihood of risk but not by just contributing to bank profits capital requirements would be another example yes sir it would be a certain percent yes of its of its assets you know okay capital requirements if you'll remember what we had was the bank and the dollars coming in from deposits sources of funds and then a second source was borrowing and then a third source was capital and then I mentioned where does this capital come from sale of stock the sale of stock not investing in stock sale of stock and then retained earnings well part of this capital and it's coming from retained earnings or we don't pay out the earnings there there's an account there which is a reserve for loan losses and so within these capital accounts what we say to bankers we don't just say this to bankers hey keep an 8 percent capital asset ratio over here the assets the uses of funds but we don't say to banker just hey keep an 8 percent capital asset ratio all the dollars flowing into the banks if all those dollars are let's say 65 and what would it speed 25 and 10 then the bank would have $100 and funds or $100 on assets and you can see that they would have 10% capital to assets but we don't say to bankers just keep 10% capital assets because the amount of capital they need to keep as a reserve is partly dependent on what kind of loans do they make over here their largest source of our use of funds is loans what do we say this is around I don't know 60 to 65 some banks 70% of total assets and so what we say to bankers is the amount of cap you have to hold on to depends on the riskiness of these assets and so if we found a bank and let's say every single loan it makes is just the best I mean really high-quality virtually no risk to a triple aid type of borrower then that Bank would be allowed to keep a smaller capital account and if we had a bank that's making a lot of really risky loans then we would have a higher requirement that they would have to set aside for losses because you know I mean that's what this whole risk rating is about is if there's a borrower that's Triple A we think we're not gonna have very many of those that go bad I mean maybe none for years and if we are making loans that are you know a rated launch or be a rated loans as opposed to triple-a then we're going to have more losses and so if we have more losses then we're gonna have to have more capital to deal with those problems so anyway what I'm saying to you is that these capital requirements are a type of regulation that have been fine-tuned over the years used to be they were not very stringent and that wasn't enough and so back in the 1980s what were they back in the 1980s like maybe six percent capital requirement six percent capital asset ratio I think back in the 1960s and then there were a lot of bank failures and then the regulator said that's not enough and then we looked overseas and in other countries they were having the same experience I believe that back in the 1980s when the US had a 6% capital asset ratio and I usually use a k2 just to myself to represent that capital asset ratio but back in the United States in the 1980s when we had this capital asset ratio of 6% I think in Japan it was closer to 2% now if you're only keeping a 2% capital asset ratio only 2% of your assets can go bad before you're wiped out and so anyway what happened was there were a lot of bank failures in the United States and overseas and so what happened was is a 1988 there was something called the Basel Accords where's basel anybody know i said at cords there were two of them but in 1980 was the Basel Accord there was another one in 2004 this was called Basel - where's Basel Switzerland and so what happened was the central banks such as the Federal Reserve and the Bank of England and so forth european central bank the central bankers got together and they talked about this problem and then what they said is you know what we need to do is we need to force our banks to have higher capital asset ratios and so that's when those started going up and that's when we got up to this eight percent or so range eight nine percent basel to us come back and fine-tune that further and there are lots of countries really all the countries with what you would call a mature financial system belong to this basel ii accord and so and i wrote down a few things well let's say that you make a triple-a rated loan or a loan to a triple-a rated company then your capital asset ratio would be adequate if it were five point six percent so on that asset if you had a million dollar asset alone to a triple-a company then you can set aside fifty six thousand dollars and that would be enough and if all you did is just make close the triple-a rated companies now of course you're going to have some liquid assets which are equivalent to cash and you don't need to set aside capital for cash but if let's just say everything on this side of the balance sheet your assets were all triple-a rated loans then you could get by with a five percent five point six percent capital asset ratio that this were be a the capital asset ratio would be twenty percent and so what I'm saying to you is if every loan you made and every security you purchased bond if they were be aerated then that Bank would have to have a 20% capital asset ratio now what we're doing in a feta in practice is each one of these loans and securities that they purchase over here has got its own capital requirement and so some of them will have 5.6 and some 20% some in between and then what we see overall is a blend of all those be rated what do you think that is you remember where the we put the line for investment grade versus junk right we started here and then we went down to where does anybody remember you don't remember and so as we go that way and here we're what Triple A this is standard and for this is Moody's and here's triple B here's BB anyway so I'm giving you the Moody's description here right anyway suppose it's B which is here what's the capital asset ratio required on that loan hundred percent what's that mean means if you loan out a million dollars just add a million dollars to your capital accounts so that's kind of saying you better not be doing that you're not gonna make much profit on those are you okay and so anyway and what does that mean add that to your capital account that's what I mean is this is that if somebody comes in and says to the banker and they've got a B credit score or credit rating and they come in say hey I want to take a take out a loan of a million dollars you have to turn to your owners and say we need a million bucks out of you all invest it in the bank so I can do this and gosh it may be profitable just because it's berated doesn't mean it's going to default it's gonna have a high interest rate so we say or you know it's gonna be a high interest rate and maybe they'll feel good about that but the point is is if your gonna make a safer loan then what you do is you just say out of them I just want a little bit will mainly use other people's money to generate these profits and so anyway you can see this and like I say there's all sorts of grades in-between here but that's where we get this number when I say the capital asset ratio is 10% I mean that is an average that is derived from all of the different assets over here that the banks holding and those cash type assets don't have any capital requirement like if you got money sitting at the Federal Reserve there's no capital requirement on that and then if you started let's say purchasing commercial paper we talked about secondary reserves and you purchase commercial paper and stuff I get oh really safe very low capital asset ratio on that and then we start getting Alone's and some securities bonds were down here in this last category and some of them may be riskier higher capital asset ratio and so then if each one of these has got its own capital requirement and we hold all the capital we need then we look and see oh that's X amount and then we could come back and say well when we hold that amount of capital here's our capital asset ratio and of course this 10 percent capital our asset ratio would also include if the bank just happens to be holding more capital than it needs to there's a minimum requirement which I was talking about there but the bank could always have 50 percent capital asterism there's a bank here in Springfield that holds almost and all the loans on its books it's actually a statewide bank and it's got a local office here but it has almost no loans and almost the only thing that's holding on to is securities which would and they are either securities by the you have issued by the US government or by the state and so that bank has a very low capital asset requirement okay questions about this these are the types of things then and we've talked about several now but these are the types I guess the for the other day and here are two more five and six and there are lots of others I've got a copy of it I don't know if it's in my office or at home I've got a copy of a book and it's about an it a half to two inches thick and the paper on it is very very thin it's thinner than just normal typing paper or anything like that kind of that tissue stuff reading almost see-through and the title of that book is the Federal Reserve Act with amendments and these are the rules and regulations that banks have to follow and it's printed on both sides of each paper and it's just hundreds and hundreds of hundreds of papers the banking industry is heavily regulated so when I come up here and give you six types of bank regulations this is just a fraction of all the rules and regulations bankers have to follow and also then we've really shortened them down by just kind of saying Basel Accord and so forth there's a lot more to it than just that okay the overall idea is summarized the overall idea of bank regulations how we're trying to make our banking industry safe and prevent failures when the Reg yes sir pardon me Fannie Mae is not a bank and so it's got its own rules and regulations but they have nothing to do with these things that we're talking about now and of course Fannie Mae is influenced by and has been political considerations in there it was set up by the government and then sort of given a little push go out there and succeed but always sort of monitored by government affected by government rules and regulations so to some extent that's a political you know it's a it's a political creature and influence then by whatever the latest trend is of Washington but know these rules do not affect Fannie Mae the general the overview is that the bank regulators go out and examine banks there's a whole bunch of rules banks are supposed to follow and the bank regulators or examiner's go out and look at the banks periodically and what they do this is an acronym is at the end they assign a score a grade to banks on how they're doing and it really comes down to how safe are they how likely are they to default you remember the issue is we don't want these bank failures to default we don't want them to default number one because they owe money to people but we don't want them to default because something bigger may happen that may cause this sort of cascading effect all the way across the United States and cause ultimately a depression okay and so we've got this heightened concern about bank safety and so anyway the regulator's come out they read exam on the banks and then they come back and this camels score relates to the risks the bank is taking the risks of it failing and let's just kind of talk about these very quickly capital is what the sea represents does the bank have enough capital and the Basel Accords basel ii is the one that is sort of the overriding set of rules but that is the question the bank regulators and the bank regulator is a regulatory body will talk more about who that is later but they sent somebody to the bank and that's the bank examiner that's an employee okay but anyway so the bank regulators look at the bank's capital see if it's holding enough capital and so one form of risk to the bank is if it doesn't have enough capital then its assets would lose value there wouldn't be enough if there's not enough capital there's not enough funds to pay out depositors and borrowers and lenders and so then that's a risk that the bank carries of failure a also you see asset quality chiefly since two-thirds of the assets are loans more cheaply looking at paid default risk on these loans okay and that default risk is evaluated in different ways what the bank has Beck in the old days what they'd have is like a little manila folder with your name on it if you were the borrower now this is computerized but whenever the bank makes a loan they've got a file on that loan and that file has got all sorts of information in it like what's the collateral on the loan right are there any restricted covenants on what this what can be done with this money there's information in there on is the loan current or the payments communion and so and just any other information pertaining to that and so the point is is and what was the credit score and so forth when the loan was made the credit rating and so when the regulator's come and say hey you show us how you're doing one thing that are interested in is it show us that these loans you've been making are safe show us that they are not overdue that they are not basically defaulted on and so then we could j st start going through and seeing how if these loans are current and so forth and this would be like in an audit they could find out that oh look here's somebody with the credit score 500 and you give him a really low interest rate is this some kind of a sweetheart deal and oh we don't see good collateral what's going on here this is a risky loan you should be charging more on this there's a high default risk on it you should be holding a lot of capital and so anyway asset quality there are some securities that banks holding we talked about the secondary reserves which would be shorter term tight securities liquid securities but also then there are bonds and so an asset cloud is an issue that pertains to that also how about this on management competence is one issue and the other one would be basically honesty competence and corruption your two big ones our competence and honesty are these bank managers confident do they know what's going on you know here's a deal and maybe you don't think about it much but bankers would be subject you know bankers are trying to run a good business an honest upright business and so they're sitting there and they're trying to deal with their customers and a fair way but there are people out there I mean at this very moment they're just sitting around scheming on stuff going huh I wonder if I could cheat somebody out of ten million dollars this way and so bankers have got to understand you know not only like oh here's the paperwork that has to be filled out to make a loan but they also have to understand the trickery that people employ to basically get a loan that they're not gonna pay back and so bankers have to be competent in what they're doing and understand sort of the state of the art and you know like ways that they could lose money not so they can go out and take risk but they need to be competent and what kind of risks are they running maybe unknowingly and so confidence is an issue and they also need to be confident and how much they're paying their employees and whether they're opening Brittain the right number of branch offices and if they are priced and there are loans accurately and things like this so confidence is a big deal and there is a certain small percent of bank managers that are simply not honest and they are just cheats and sometimes these bank managers are high up and sometimes they're not so high up like you could be a loan officer making loans to friends on very favorable terms and you know like here's a loan I know it's not gonna be paid back here's the money I loan it to you at 6% good luck okay there have been cases in the past where that kind of thing takes place but then there's a larger conspiracy underway like you come in maybe I'm a loan officer and you're my friend and you come in and say oh I would like to I usually do that wing thing hey how you doing and then I'd like to take out a loan Oh what are you gonna do with it I'm gonna build a hotel oh that's a good idea a lot of winking back and forth and then I say well you know we have to fill out all those paperwork and you say okay and maybe what we do is we've got some cohorts over here that aren't in the room and doing the winking but maybe one of the cohorts would be somebody that is appraising property and maybe there's some piece of property out here and it's worth a hundred thousand bucks but we pretend it's worth ten million dollars and then we go get an appraiser to say yeah here's a 10 million our piece of property and so then we say oh you know what I am only gonna loan you eight million dollars on this property because you have to put down 2 million then you go ok so you take that 8 million dollar loan and then you go out and buy a hundred thousand dollars worth of property and there's really not a 10 million those with a property or eight or anything else but I say oh hi the loan officer I say this is a good loan it was a 10 million dollar piece of property I only owned 8 million dollars on that 2 million dollars I didn't come up with out of their home pocket this borrower did no not really and we could be working with somebody over here also that would falsify their kind of information about your business and so forth and so anyway there is sometimes sometimes would be at the loan officer level sometimes at a senior level but there's sometimes people that are just not honest but most often they would not be confident and things would just overwhelm them they think they're doing a great job and they are doing a great job until the day somebody comes in and goes well you know that money we loaned out the other day well we lost 25 million dollars and now we're broken how could that happen totally surprised well that's not dishonesty that's same confidence what was a story I saw this on c-span one time where there was a bank and Oklahoma City and it was in a shopping mall and it was a small little Bank you know people shopping in the mall would go and just like go in this small little area and do business and so it was kind of a no big deal kind of a bank and then they started they made a couple loans and this was down in Oklahoma and so they made a couple of loans to guys that were out for oil and those guys hit oil and then they came in to pay off their loan and the bankers thought well we charge a pretty high interest rate and that got paid off that was very successful and so then they said you know what we're gonna do more of that so then they started making more and more of those loans in the quote oil patch and those loans were paying off and they were charging high interest rates and then they said wow this is a great idea and then what they did is they start advertising for large CDs they started put in their you know advertisement out saying we're selling large TVs and everybody else in the country is paying let's say 5% we're paying six and the money just started coming in and then they just start making more and more loans an oil patch and this was at a time when oil prices were high and many are just doing great and so then after they had done that for a while some a big bank up in Chicago came down to him and said hey you guys are really successful and they said yeah we really are and the big bank up in Chicago says we wish we could get in on some of that action but you know we're a parent Chicago and we don't have an office down here in Oklahoma Texas and so forth and then this Bank in Oklahoma City and shopping mall they said that's okay because we could help you out we'll just sell you some loans this is be like loan participation we'll just say you someone's and then the bank in Chicago said wow we'd love to have them so then at this point this Bank down in Oklahoma City is they don't need to be quite so careful because somebody's gonna buy their loans and so they're just lending that money out and then turn around and selling those loans to some other bank and that other banks taking the risk now it's their money that we are lending after all we're not actually lending their money what we're doing is we're lending our own but then we're getting ours back when we sell the bank to some other loan to somebody else and what's happening and this is all reported in a Wall Street Journal that Iran is like at the end of the year these guys would calculate this is an Oklahoma City they would calculate their profits at the end of the year and then they would have parties and they would like drink champagne out of their cowboy boots you know and they are just live life is good and this just goes on and on and on and so then this bank in Chicago it's just buying billions of billions of billions of dollars with these loans and then another bank or two or three several start going Wow where are you guys in Chicago are you coming up with all these loans and they said oh we got a buddy down in Oklahoma City and wha blah blah and so then these other banks are going well I wonder if we get down on the action and that Bank in Chicago says we'll put in a good word for you and so then these other banks start buying loans and so these loans are just kind of going around the United States not everywhere but a select number of banks and the Chicago bank didn't just tell their buddies where these loans are but then they offered to stand behind a lot of them these loans are so good from that Oklahoma Bank Oklahoma City Bank that if you lose will stand mine so anyway these guys down in Oklahoma City and just getting rich okay and then what happened was you know after you go out and you just drill for oil and drill for oil and you just keep finding it find it find it finally the places where you can find oil or taken up you know and then people start drying a drilling for oil and then I said that we're dry and then they start hitting dry holes and also a second thing that happened was the price of oil went down it had been high and then it went down and so these guys in the oil patch that were drilling for oil some of them were hitting dry holes and then the ones that were hitting their self in the oil but they weren't getting as much so they start telling these guys in Oklahoma City we're having trouble and then the guy in Oklahoma City those bankers they start telling us guy in Chicago who started telling his buddies and Washington State and different places trouble and so then billions and billions of dollars worth of loans went been now these guys were incompetent they weren't crooks they were just incompetent making too many loans in too small of an area they were not diversified okay and they weren't setting aside enough reserves and then those guys in Chicago they were just totally lousy managers I already told you about them I told you about the eighth biggest magnetised it's going broke well the eighth biggest bank in the United States went broke for a lot of problems but one of them is they were letting loan decisions be made by a couple of you know yeah who's down here in Oklahoma City at a shopping mall I didn't know anything about the oil patch okay and by the way then these other banks that were friends with the Chicago bank continental Illinois was the name of the bank they were going broke these are huge bankruptcies and it cost billions of billions and billions of dollars to tie this up I told you the one the one in Chicago was so big that they couldn't actually close the doors there was nobody to merge with them and there wasn't enough cash in the FDIC reserve fund to pay out the depositors so that was the bailout then they just took over the management of that bank for several years okay so this is an example of incompetence there was an example I'll tell you in Tennessee around the same time and in Tennessee what happened was the governor's brother it seems to me like it's not the current governor but several years back the governor's brothers seemed to me like and his family's in the banking business and they owned like a main bank but then they owned other banks scattered around the state and so then what would happen is they were being examined by their regulators and so then the regulator's would come in and start looking at stuff and then say well you know we find a few deficiencies but overall okay and then like next week or something like that they'd go to and they're examining banks all around the state and so then they go to another bank but in the same chain or in the same group and they would examine that bank and then later on a week or two or a month why did they go to another bank that's owned by the same folks come to find out this bank was I mean this group of banks they were just you know totally corrupt and broke and what they were doing is they had some assets that were good loans and things like that and securities and so what they do is after the examination they would just ship them over to another bank and then the examiners would come in and look at this oh ok ok and then those would get shipped over to another bank and then they go over an exam and that one that one looked ok and these guys have just been making loans that weren't being paid back so anyway there's just any number of things that happen by the way they the way they found him is they examine all the banks on the same day and then it was like oh oh got him and I think they showed up but the CEOs house and he was loading records into his trunk to try and take him out and burn him or something like this but I'm in a lion feel I don't know but anyway they caught him at his house and so sometimes you have the corruption and other times you just have you know like not good bank managers but these are the types of things and by the way the corruption very often happens at lower levels the top management they think they're doing a great job but there's somebody three layers down in the organization and they may be corrupt so anyway the examiners are looking at issues like this the general rule is it's just a general rule but it's a rule that regulators know when you see a bank that is growing rapidly and I don't mean to say 8 or 10 percent a year but if you see a bank that is will pick a number out a 2 billion dollar bank this year and then 3 years later it's a 12 billion dollar bank then they start going wow I wonder if something's wrong they're just that fast fast fast growth is a tip-off banking in general if you just go out here and find a safe bank that's well managed and so forth it's gonna grow 2 percent 5 percent 6 percent in a year and they say that's pretty good you know our banks getting a little bigger all the time our profits are growing we feel good about ourselves but when you see a bank that's doubling in size year after year after year then there's a good sign that what they are doing is this on this side they are purchasing funds they may be borrowing a lot or they may be raising the interest rate on their CDs and so a lot of managed liabilities are coming in where they are purchasing funds and they are growing rapidly and then they're going out and taking a lot of risk on this side of the operation and so bank examiner's are and regulators are looking for rapid growing banks and that is like a bell is going off saying closely at this one e earnings or profits right earnings and they don't they look at current earnings but they're also making a projection about the future but most of the capital that banks have come from earnings from their profits that they don't pay out as dividends and they keep plowing that Bank back into the bank's operations and so they want to know if the bank's gonna stay profitable as long as it has some earnings then what happens is it's not going broke at least this year but anyway they want to know about is this bank going to continue to be profitable so they can continue growing their capital accounts okay and stay in business liquidity is the L the banks got to be liquid you've always got to be able to pay your depositors if they ask to withdraw money you always got to be in a position to make loans right and the liquidity there's there's never enough at a time of a bank run and so what you want to do on liquidity is never get to the point where people are question that you always want to have a have enough liquidity so anytime a valid request is made you can always say yes what do we have now yes there's camels as a sensitivity I know what you're thinking I'm a sensitive guy but that's not what we're talking about here sensitivity to changes on asset prices changes in interest rates okay changes in interest rates we talked about interest rate risk if interest rates go up the value of bonds and the value of loans is going down so it could be that the banks in a good position today but if interest rates went up 1% they'd be broke and so that is what the regulator's want to know is how sensitive are they to a change in interest rates and we talked about some of those things that bankers do to avoid interest rate risk is don't hold a lot of long-term loans on your books you know sell them off if you make them that would be an example okay or take these hedging operations that I mentioned where you basically are every time you take a risk interest rate risk by making a long-term loan make some other investment that if the loan loses value there's other investment gains value and then they ffset each other and so anyway and and the same thing is true interest rate sensitivity is also asset sensitivity or asset value sensitivity because increase in interest rates decrease in the value of bonds decrease in the value of of loans and so these are decreasing the value that's a decrease in the asset value so how sensitive is the bank's financial situation to a change in interest rates okay and I mention another thing I ran over here too quickly but adjustable rate loans or flexible rate loans where that if interest rates go up the banker just increases the interest rate on those loans so anyway the bank regulators are looking at all of these things now when they get done they've got a score and the score ranges from one to five and the one is the best that's the highest and a five means imminent failure like could be tomorrow okay and what the regulator's basically say is this you know if we come in and we've evaluated all this stuff and if we see you're all one or a two we just leave the bank alone we shake hands with them and say see you again next time and leave and tell them you're doing a fine job and if we see three four or five then what we say is you know you guys need to work a little bit on this we're not really satisfied with what we see and there's a certain about a negotiation a certain amount of advice giving here's what we where we see the problems you need some more capital or you're holding too many risky loans you know or you don't have enough liquidity or or whatever these types of things that we're talking about here and so the regulators step in and they'll negotiate something with them and they say here's what we expect to see and the regulators have a lot of power over these banks they can they can negotiate but also they can just issue an order and say here's what you're going to do or else or else what or else how about this we'll find you a big amount of money or else how about this we'll remove you from office we'll just tell your regulators your regulars will tell your shareholders your board that you are gone or we can remove people from the board and you're out and so was it I think it was Bank of America was talking about and maybe 19 the guy who was running Bank of America I think he was saying back in 2008 that I don't know if as a Federal Reserve or the Treasury Department was basically saying here's what we want you all to do this is at a time of this financial crisis and if you don't do that then we will remove members of your board and so it can be done in a friendly way it can be done in an unfriendly way but once the regulator's decide something's going to happen it will happen what we'll talk about next time as the regulators and some other problems with regulation so long