30
that have such bonds in their available-for-sale
portfolio. Then the value of those bonds de-
creases in the assets column of their balance
sheet and that value reduction must then be
made up for from the bank’s equity.
When a bank eats away at its equity from the
right-hand side of the balance sheet, it must
supplement that equity immediately so that it
complies with the capital requirements and re-
mains solvent. When the financial crisis caused
the bottom to fall out of the share markets,
the government was often the only party that
was prepared to buy in the (share) capital of
a financial institution in difficulty and thus to
make up for the deficit that had come about in
its equity due to the decrease in market value
of the assets.
However, market value is by definition virtual:
it reflects a price that the market players are
willing to pay for a financial product at one spe-
cific moment, but does not necessarily reflect
the real intrinsic value of such a product.
The lack of capital, however, was not the only
problem that certain banks had to cope with
during the crisis. A serious liquidity problem
also threatened because too many assets were
refinanced over the long term in the balance
with short-term loans on the financial mar-
kets. When the financial markets closed off the
money supplies, this leverage caused serious
problems for a number of banks.
Before the Basel III capital rules, the equity of a
sound bank was between 3% and 6% of the bal-
ance sheet total. That means leverage between
17%
and 33%. Now that the central bankers at
the Bank for International Settlements in Basel
have decided to tighten the capital rules for the
banks, the equity will be increased significantly
in the next few years and the leverage will be
phased-out.
In Belgium that has already happened. The bal-
ance sheet total of the Belgian financial sector
has been reduced by nearly 30% in the last five
years. The dependence on the financial markets
has decreased and the duration of the funding
has been extended. There is therefore less to be
refinanced, and the need to call on the financial
markets is less frequent.
How does a bank earn its
money?
In essence, a bank accepts short-term deposits
and uses them for long-term loans. Whether
the profit and loss account shows profit or loss
in the end is determined by the difference be-
tween the interest that a bank charges to bor-
rowers and the interest it pays to savers.
2.
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PROSPERITY