Browsing the blog archives for October, 2008.

Federated Identity Management

Virtual Reality

One of the last barriers to usability on the web has been the insane prolification of accounts and passwords.  Virtually every website has some kind of account and password scheme, which by itself is not so bad, but in aggregate results in an explosion of identities and passwords to keep track of.

Most users try to contain the problem by using the same account ID and credentials on as many sites as possible, but this is not always possible due to differing password rules and different account name structures.  More recently the convention of using an email address as the account name (an old trick borrowed from FTP) has helped but is not universally available.

Federated identity protocols such as OpenID have been around for some time but are only recently gaining critical mass.  Most recently both Google and Yahoo have conducted their own usability research and discovered the obvious – federated identity is sorely needed.

More importantly both of these large Internet properties have agreed to support OpenID.  This should result in enough critical mass to finally drive an industry standard.  Increasingly, leading applications will start to adopt this emerging standard and the Web will be a better place for it.

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A Better Type of Financial Intervention?

Financial Crisis

At the request of European Union finance ministers meeting in Nice (Sept. 12-13), the European Investment Bank will modernise and increase significantly its volume of lending to small and medium-sized enterprises in 2008 and 2009 to help mitigate the effects of the current credit crisis.

Ministers agreed the Bank should target loans to SMEs totalling 15 billion euro over the two year period as part of a global envelope of 30 billion euro. This level of lending would represent an increase of around 50 percent compared with 2007, when the Bank lent 5.2 billion euro to SMEs via its network of partner banks from the private sector.

In addition, the EIB announced to ministers its intention to give a new 1 billion euro mandate to its European Investment Fund subsidiary to provide mezzanine finance to SMEs.

The increase in lending will accompany sweeping reforms to the EIB’s SME loan product that should make loans both simpler and more attractive for companies and the EIB’s partner banks.”

Instead of propping up and rewarding reckless banking with bail out packages, it is far better to secure the underlying foundation for the economy. 80% of economic activity in both NA and Europe depends on the health of Small and Midsized Enterprises (SMEs) who are currently finding it difficult to access cash for normal operations.

SMEs routinely need to finance receivables, lease equipment, finance inventory, and make leashold improvements in their physical infrastructure. Most banks are currently jacking up interest rates and lowering credit ratings as they attempt to squeeze SMEs for the cash that the banks need to make up for their mistakes.

Failing to help SMEs will result in massive closures, job loss, and an economic meltdown that will make the Great Depression look like an economic plateau. Already 20% of US car dealers are on the brink of bankruptcy because they cannot finance their inventory.

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Could Canadian Banks Vapourize As Fast As Wachovia?

Financial Crisis


In 2006, Wachovia had a market capitalization of $88 B USD and was the 3rd largest US bank. By July 2008 this sank to $33 B even though shareholder equity was $75B and Tier 1 capital ratio was 8%. In other words the market valued Wachovia at 50 cents for every dollar invested by Wachovia’s shareholders.

By end of Sept Wachovia was kaput and was forced to sell its banking operations to Citigroup for $2B. Citigroup paid Wachovia’s shareholders less than 3 cents for every dollar they had invested into Wachovia’s Tier 1 capital. That’s a destruction of $73 B in shareholder equity in under 2 years.  Even with the subsequent higher offer from Wells Fargo, Wachovia’s shareholders realized less than 30 cents on the dollar.

Wachovia’s downfall was triggered by a bad acquisition of Golden West’s mortgage business that resulted in Wachovia holding $122 B in crazy mortgages. Although Wachovia had almost $1 Trillion in “assets” it really only had $75 B of invested capital to cover $122 B in suspect loans. Ooops.

The market cap of Wachovia was less than the shareholder equity and was a clear signal from the markets that the majority of those loans were bad.

Canadian Banks

Meanwhile the largest bank in Canada is the Royal Bank of Canada with a current market cap of $63 B and also has a “solid” Tier 1 capital ratio of 8%. Total shareholder equity is only $29 B. So far the market is expressing confidence in the “asset” quality of the bank since the market cap is greater than total shareholder equity by about 2:1.

In theory, the top 3 banks in Canada could vanish as fast as Wachovia since their total shareholder equity combined is less than the $73 B destroyed in the Wachovia collapse. The risk currently appears low as the smallest of the Canadian banks by market cap is the Bank of Montreal with a market cap of $33 B and total shareholder equity of $18 B. Not quite 2:1 but not bad – even though the BMO’s tier 1 ratio is 9.9% (stronger than RBC).

So far so good, but let’s bear in mind that a top rated capital ratio of 10% means that the bank is still 90% leveraged!  As long as deposits exist to cover this leverage, and as long as the depositors are willing to trust the bank with those deposits, the bank will be strong.

The key leading indicators of bank stability are deposit ratio and shareholder equity to market cap.   If these are insufficient – watch out!

Tier 1 Capital Explained

The Tier 1 capital ratio is the total amount of “assets” managed by the bank divided by the amount of money actually invested by shareholders in the bank plus the cumulative retained earnings made by the bank. A ratio of more than 6% is considered good by international banking standards and a ratio of 8% or higher is considered “excellant”.

Since banks loan money, the debt owed to them is considered an “asset” even though in the real world it is actually a liability from the perspective of the borrower. Since it is no fun to only lend money you actually have, even though your savings deposited into the bank are actually liabilities owed by the bank to you, banks also count them as “assets” because they are used to provide the funds for the loans made.

Banks are allowed by law to lend up to 25x more than what is actually invested into the bank. If the Tier 1 ratio is 8%, then the banks actually owe 12.5x more money than is actually invested.

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