Great post! The part on “capital optimization” is quite interesting. I recently read a coverage report on EQB (a mid size Canadian bank) and the analyst mentioned how there is upside to higher ROE if the bank is approved by OFSI to use internal risk-based models to calculate RWA. So, when a bank becomes big enough, they’re allowed to use their own RWA approach and boost their CET1 ratio, nice!
I have wanted to research EQB for like 6 years and never got around to it lol. The stock's tripled since then.
But yes, the business should be worth more if the bank can operate with less capital (without putting itself at risk of not having enough capital to survive when times are bad). It wouldn't require as much incremental capital to grow, and so it would generate more free cash flow.
They've still got to pass stress tests and such, and the tests aren't thought-up by the banks, they're imposed by the regulators, so you still need to have the amount of capital the regulators want. Otherwise you fail the test and they may tell you to stop buying back shares and possibly cancel the dividend, at least until you rebuild capital to the levels they want. So it's definitely not a free lunch :)
Great post! The part on “capital optimization” is quite interesting. I recently read a coverage report on EQB (a mid size Canadian bank) and the analyst mentioned how there is upside to higher ROE if the bank is approved by OFSI to use internal risk-based models to calculate RWA. So, when a bank becomes big enough, they’re allowed to use their own RWA approach and boost their CET1 ratio, nice!
I have wanted to research EQB for like 6 years and never got around to it lol. The stock's tripled since then.
But yes, the business should be worth more if the bank can operate with less capital (without putting itself at risk of not having enough capital to survive when times are bad). It wouldn't require as much incremental capital to grow, and so it would generate more free cash flow.
They've still got to pass stress tests and such, and the tests aren't thought-up by the banks, they're imposed by the regulators, so you still need to have the amount of capital the regulators want. Otherwise you fail the test and they may tell you to stop buying back shares and possibly cancel the dividend, at least until you rebuild capital to the levels they want. So it's definitely not a free lunch :)