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Finance/Investing Question

 
 
Reply Sun 14 Oct, 2018 07:48 pm
This might be a little esoteric, but there are smart people here, so maybe someone will know. Is a high debt to equity ratio good or bad for a bank.
 
Thomas
 
  2  
Reply Mon 15 Oct, 2018 02:33 am
@Brandon9000,
Brandon9000 wrote:
This might be a little esoteric, but there are smart people here, so maybe someone will know. Is a high debt to equity ratio good or bad for a bank.

To help me answer your question, can you clarify who has the high debt-to-equity ratio? The customer or the bank? Also, good for whom, the customer or the bank?
Brandon9000
 
  1  
Reply Mon 15 Oct, 2018 07:01 pm
@Thomas,
Is it good for a bank to have a high debt to equity ratio? There is no customer in the question.
Thomas
 
  2  
Reply Tue 16 Oct, 2018 04:10 am
@Brandon9000,
It depends on how high is "high". As you know, banks make their profits mostly by borrowing money at low interest rates (through their customers' checking accounts, in particular) and lending it out at a higher interest rate or investing it in profitable projects. If their debt-to-equity ratio was zero, they'd have no cash to lend out and do their business with. If it was too high, it would threaten their solvency when their cash flow dries up.

I am not an expert on bank stocks, but for what it's worth, Investopedia says a typical debt-to-equity ratio for banks is 2.2 for commercial banks, 3.3 for investment banks. This might give you a baseline for deciding if the debt-to-equity ratio of the bank your considering is "too high" or not.

Another thing to watch: When a bank goes under, the reason is usually not that the overall debt is too large, but that its time to maturity is too short. Much, sometimes most of a bank's debt is the balance in its customers' checking accounts, which is theoretically redeemable at a moment's notice. So when many customers decide at the same time to withdraw their cash holdings, this can create a risk to the bank's solvency.

To assess this risk, it's important that you pay attention to your bank's reserves --- how much of its debt it holds in cash or cash deposits at the central bank. Again, I'm not qualified to advise you about specific reserve amounts or ratios. But you should get a decent picture by comparing your bank's reserves to the industry average, and to the minimum requirements set by the Fed.

Hope that helped.
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engineer
 
  3  
Reply Tue 16 Oct, 2018 05:37 am
@Brandon9000,
If you look up the debt to equity ratio of all the big banks, you can see they are all around one, but during the financial crisis, they went up to three or so. I think being around one is optimum. Lower and they are not maximizing their profit potential, higher and they are overextended.

BofA Ratio over time: https://www.macrotrends.net/stocks/charts/BAC/bank-of-america/debt-equity-ratio
JP Morgan Ratio over time: https://www.macrotrends.net/stocks/charts/JPM/jpmorgan-chase/debt-equity-ratio
Citibank Ratio over time: https://www.macrotrends.net/stocks/charts/C/citigroup/debt-equity-ratio
Thomas
 
  2  
Reply Tue 16 Oct, 2018 05:54 am
@engineer,
Wow! I had no idea investopedia could be so wrong! Thanks for linking to the raw data!
0 Replies
 
Brandon9000
 
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Reply Tue 23 Oct, 2018 06:13 pm
Thanks, folks. several of my investments have been and will continue to be stock in banks. I knew that the D/E ratio of a bank is not to be judged the same way one judges the ratio for a non-lending institution.
0 Replies
 
 

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