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Banks Have 99 Problems But Liquidity Ain't One

In addition to TARP, which shored up hundreds of banks, including the nation's largest bank holding companies, which were initially forced to take at least one infusion of capital, with the government being issued preferred shares in return, the FDIC's Temporary Liquidity Guarantee Program included the temporary removal of all limits on deposit insurance for noninterest-bearing transaction accounts, which included most business checking accounts. This swept away the fears of small businesses that their working funds flowing through banks could disappear.

The unlimited deposit insurance coverage on noninterest-bearing transaction accounts will end on Monday.

Stress Testing Liquidity

Mosby said that "by the end of 2008, our Large Cap Banks' coverage of a retail run on the bank had fallen below 100%," but because of actions by the FDIC and the Federal Reserve, "the coverage ratio for a retail run on the Large Cap Banks has risen to above 150%, the highest level we have seen in the 2000s. Additionally, wholesale and institutional coverage ratios have improved from below 200% to around 400% today."

The analyst tested the liquidity positions of the large banks under three different scenarios, using Basel guidelines, but also factoring in U.S. banks access to borrowings from the Federal Reserve and the Federal Home Loan Banks (FHLBs), as well as historical bank-run data. The first scenario would be a runoff of wholesale funding. The second would be a loss of institutional funding. The third would be a retail run on deposits of 20%, since Guggenheim's "analysis has shown that about 20% of retail deposits will run-off in that scenario as depositors become worried that access to their accounts may become limited."

Testing the above scenarios, Mosby estimated that the 15 large-cap banks covered by Guggenheim "could potentially lose $3.6 trillion of funding during a full-blown liquidity crisis. However, the sale of liquid assets, access to emergency funding from the Fed and the FHLBs, and the repo or sale of collateral could raise over $5 trillion. Thus, the median coverage for our Large Cap Banks is 171%."

The Basel liquidity tests do not account for FDIC deposit insurance or FHLB access, because European banks don't have access to either. "As a result, the Basel guidelines incorporated the European level of expected run-off, which we have assumed is 30% for this analysis," Mosby said. Assuming the 30% deposit run, with no FHLB access, "the median coverage ratio from 171% to 138%," he said, adding that BB&T (BBT) and U.S. Bancorp (USB) "would fall short of covering their respective loss of funds in this scenario." Then again, "this liquidity crunch can be easily fixed today by lengthening borrowings outside the 12-month window incorporated into the liquidity crisis analysis, especially since long-term rates are currently so low."
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