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Business Comment

Ben Chu: These banks' fortress balance sheets aren't as impregnable as they look

Outlook The London Whale turned out to be more like the London goldfish. JP Morgan's results for the final three months of 2012 today confirmed that Jamie Dimon's Wall Street juggernaut emerged from its annus horribilis in surprisingly decent shape. Revenues were up 10 per cent on the same period of the previous year. Profits were 53 per cent higher. For the full year, profits came in at $21bn (£13bn), 12 per cent higher than 2011. The $6bn trading loss resulting from the activities of the derivatives trader Bruno Iksil, uncovered in May, turned out to be no more than a small blip for this profit-making machine.

True, Mr Dimon's 2012 bonus has been cut in half – a punishment for failing to spot the whale in the fish pond. He'll have to scrape by on just $11.5m. Poor dear, but he'll probably live. And Mr Dimon sounded bullish unveiling the latest results, boasting once again about JP Morgan's "fortress balance sheet".

The trouble is that this "fortress" looks rather pregnable. The bank reported a total capital ratio of 11 per cent. That sounds very comfortable. But beware. The detail in the fourth-quarter results shows JP Morgan shareholder equity at $204bn while its total assets were $2,359bn. So JP Morgan's equity cushion is actually just 8.6 per cent of assets. In other words, if those assets were to slide in value by 8.6 per cent, the bank would be bust. Not so comfortable after all.

There was a similar story at Goldman Sachs, which also reported its fourth-quarter 2012 results today. The bank pointed to a capital cushion of 14.5 per cent. Again, that sounds comfortable. But dig deeper into the report and it turns out that Goldman Sachs' shareholder equity was $72bn at the end of last year while total assets were $939bn. Goldman's true equity cushion was, then, just 7.7 per cent of assets. Again, not so comfortable as we were initially led to believe.

The gap between the image and the reality of capital buffers when it comes to our own megabanks is even more alarming. Barclays will not report its full 2012 figures until next month, but in the third quarter of 2012 it pointed to a capital ratio of 11.2 per cent. Yet it also showed shareholder equity of £54bn funding total assets of £1,599bn. That's an equity cushion of just 3.3 per cent. In the third quarter, Royal Bank of Scotland said its capital cushion was 11.1 per cent. But with £74bn in shareholder funds underpinning £1,377bn in assets the majority state-owned bank's true safety buffer was just 5.3 per cent.

This striking difference between these banks' headline capital levels and their actual equity cushions lies in the lenient international accounting rules governing what funding liabilities the banks can count as capital and also the extraordinary leeway they have to decide how much capital they need to hold against their various assets. Investors would be well advised to focus on the stripped-down ratios rather than those the banks choose to wave in their faces.

And taxpayers? Are these buffers sufficient to safeguard the public from having to bail out banks should they again hit the rocks as they did in 2008? Here's a way of answering that question. Consider how much equity a bank like Barclays or RBS will require you to put into your house before they'll give you a mortgage. As the Council of Mortgage Lenders confirmed today, you'll be lucky to get away with a deposit smaller than 20 per cent of the value. What these ratios seem to tell us is that bankers are between two and four times more sober and financially reliable than the typical first-time house buyer. Does that sound to you like an accurate description of the world in which we're living? Thought not.