Banks are not the safe havens of yesteryear, if there ever was a yesteryear. The 2008 financial crisis showed us all that banks often have no clue about the risk they take when making loans. Investors have a few tools to evaluate bank risk before they stroll up to the teller window or click "buy" in their brokerage account.
The Texas ratio is explicitly focused on those asset categories that immediately threaten a bank's solvency. The capital adequacy ratio (CAR) is a more complex assessment of a bank's ability to survive impairment of several asset categories. The Texas ratio is simple and straightforward. The CAR's utility depends on how closely the bank adheres to several accounting principles and whether it caveats its exposure by adjusting the risk weights.
A bank with a poor Texas ratio must make it healthy by making operational changes. It can increase its loan loss reserves, sell off its REO inventory, pursue delinquent loans, or sell non-performing loans to third-party collectors. In other words, the Texas ratio requires a bad bank to solve its problems. The CAR requires its own set of fixes that probably take longer to execute than those for the Texas ratio as they require significant shifts in the bank's strategy. It is important to note that Basel rules allowing a risk weighting of zero percent for government debt in the CAR may be unrealistic in an era when governments allow their central banks to devalue currencies with quantitative easing.
The bottom line is that understanding the Texas ratio and making changes to improve it are both easier than doing the same for the CAR. Both metrics are useful and I don't intend to buy stock in any bank until I understand how they stack up in each ratio.
The Texas ratio is explicitly focused on those asset categories that immediately threaten a bank's solvency. The capital adequacy ratio (CAR) is a more complex assessment of a bank's ability to survive impairment of several asset categories. The Texas ratio is simple and straightforward. The CAR's utility depends on how closely the bank adheres to several accounting principles and whether it caveats its exposure by adjusting the risk weights.
A bank with a poor Texas ratio must make it healthy by making operational changes. It can increase its loan loss reserves, sell off its REO inventory, pursue delinquent loans, or sell non-performing loans to third-party collectors. In other words, the Texas ratio requires a bad bank to solve its problems. The CAR requires its own set of fixes that probably take longer to execute than those for the Texas ratio as they require significant shifts in the bank's strategy. It is important to note that Basel rules allowing a risk weighting of zero percent for government debt in the CAR may be unrealistic in an era when governments allow their central banks to devalue currencies with quantitative easing.
The bottom line is that understanding the Texas ratio and making changes to improve it are both easier than doing the same for the CAR. Both metrics are useful and I don't intend to buy stock in any bank until I understand how they stack up in each ratio.
