How to vet your bank

Source: The Reformed Broker

One of my favorite blogs is Sovereign Man. A recent letter contained valuable information on how to vet a bank. I recall giving a friend similar, though less financially sophisticated, advice when the recent banking crisis was just beginning. She looked so skeptical! “Know the CEO???”

She probably banked at one of the big guys, while our institutions, where we had banked for three or more decades, are invisible on the world money stage: a local savings & loan institution and a credit union.

The illustration, BTW, is from The Reformed Broker blog, which may join my blog roll soon. While S.M. advises having foreign bank accounts, his vetting advice applies to any bank. Here are his thoughts, edited by IFO:

Start Quote: Question from a reader: “…you talked a lot about offshore banking. What’s the best way to check out these banks and brokerages to see if they’re safe?”

We live in a time when you can no longer assume away counterparty risk simply because banks and brokerages are regulated by a government. If you’re depositing money with someone, you should look at them like a financial partner. And, as with any partner, it’s imperative to get to know who you’re dealing with.

Unfortunately, there is no easy way to do this. You can’t just Google “Is XYZ Bank safe?” It takes a bit of homework. With banks and brokerages, the first place to start is by talking to key people within the organization. Ask to see the financial statements. Talk to them about the company’s operations. Ask about their audit history.

At a high level, this is mostly a test. Anyone in the business of being a financial steward of other people’s money should be completely transparent. If you get the sense that they’re uncomfortable discussing these issues, or that they don’t really know, it’s a major red flag.

I also dive into the books and look for positive cash flows, strong liquidity, and adequate capitalization. Banks can book phony profits out of thin air using clever accounting tricks, but cash positions are much more tangible.

I’m also deeply concerned about liquidity. I want to see very high levels of liquidity that can withstand bank runs in case of market panic. If a bank has $123 billion on deposit and only $4.6 billion in cash (a ratio of just 3.25%), I’m not interested.  [SM Editor’s note: those are Suntrust Bank’s actual Q3 numbers.]

Islamic banking centers tend to have higher liquidity ratios; Abu Dhabi and Lebanon are great examples, and both accept most non-resident nationalities (except Israelis) as customers who show up in person with passport in hand.

Capitalization is also important; you obviously want to pass if a bank is teetering on insolvency, or if the slightest market rout would wipe out all the equity.

Unfortunately this is much more difficult to ascertain. Bank loan portfolios are notoriously a black box of assets– does anyone really know what’s on Bank of America or Deutsche Bank’s books? Nope. And neither do they.

Conduct your own research. I often drive around town to get a sense of what the bank is investing in. Banks often proudly display signs at construction sites and the like, showing off to the world that they loaned $XYZ to the project.

When you see enough of these, you get a strong sense that the bank is incredibly exposed to the real estate market. At that point it’s a judgment call.

Even better, though, I’ll often try to go through a borrowing process myself. If a loan officer is just begging to throw money at me with some ridiculously low interest rate, minimal down payment, and no credit check, I run away like a scalded dog because I know they’re not doing their homework on anyone else either.

Ideally, you want to see very strict, conservative lending practices and formal due diligence. I could go on about this for pages and pages, but I hope this gives you a good start.

Next question, “What are your thoughts on Malaysian banks?”

If you’re living overseas, it always makes sense to have a local account for small purchases. After all, you’ve got to pay the cable bill somehow. But for real savings, pick the place that’s best for your money.

Kuala Lumpur is right next door to Singapore, which is one of the best places in the world to bank. Singapore has never had a bank failure, and the banks there are extremely well capitalized. It would be well worth the short trip down to Singapore to give your savings a good home.

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About InvestingforOne

I've been investing in various assets by myself using a discount broker for many years. Over that time, I've developed some theories that others might find useful. Plus, there is more to investing than money. Time, talent, work, friends, family all go into developing a good and satisfactory strategy.
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