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Winter 2013 Hamilton Financial Index

Winter 2013 Hamilton Financial Index

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This update to the Hamilton Financial Index shows the progress on improving the safety and soundness of the financial sector. It also features analysis of improvements in bank capital and the importance of increasing the supply of safe financial assets.
This update to the Hamilton Financial Index shows the progress on improving the safety and soundness of the financial sector. It also features analysis of improvements in bank capital and the importance of increasing the supply of safe financial assets.

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Published by: Hamilton Place Strategies on Aug 04, 2013
Copyright:Attribution Non-commercial

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11/05/2013

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The Hamilton Financial Index
 
The Financial Services Industry Continues To ImproveSafety And Soundness
“Credit flows are the lifeblood of a well-functioning economy. By channeling funds from savers to borrowers, financial institutions enablebusinesses (and individuals) to pursue projects and activities.”
i
 This sentiment expressed by Pedro Amaral, a senior economic researcher at the Federal Reserve Bank of Cleveland, illustrates the importance of thefinancial services sector to the economy and why its safety and soundnessare of paramount importance to policymakers, members of the financialservices industry, and U.S. citizens.Since the crisis, members of the financial industry and policymakers across the globe have worked together to improve the safety and soundness of  the financial sector. The rulemaking, implementation, and complianceprocesses are still ongoing with much work still to be done. Even so, thefinancial services sector has already made significant changes to strengthenitself against potential risks.The Hamilton Financial Index (HFI)was constructed to monitor thisprogress. Combining both financialstress and industry-levelcapitalization, the HFI provides asnapshot of the risks in the systemand how prepared financial firms are to confront these challenges.This analysis finds that America’s financial institutions are significantly safer and stronger than even in the years prior to the crisis. At the same time, the HFI shows the weaknesses of the financial system during the crisis, thus highlighting the importance of current efforts to strengthen thesystem.This report details:
 
The 2012 fourth quarter reading of the HFI
 
The improvements in capital and risky assets
 
The role of the EU and safe assets in financial stress
Key Findings:In the fourth quarter of 2012:
The HFI is 1.28, a recordhigh.
U.S. banks’ Tier OneCommon Capitalincreased to $1.13trillion.
U.S. banks’ Tier OneCommon Capital ratio is12.6 percent, a year-over-year increase of 1.3percent.
The ratio of Risk-Weighted Assets toTotal Assets fell 1.3percent year-over-year.
Financial stress declined.Matt McDonaldPatrick SimsRuss GroteHamilton Place Strategies805 15th Street, NWSuite 700Washington, DC 20005(202) 822-1205
 
“This analysis finds thatAmerica’s financialinstitutions aresignificantly safer andstronger than even in theyears prior to the crisis.”
 
 
Hamilton Place Strategies | 2
The HFI Is 28 Percent Above Pre-Crisis Norms
 The fourth quarter of 2012 reading of the HFI is 1.28, or 28 percent above pre-crisis norms (Exhibit 1). While the decline of financial stress since the crisis hasimproved the HFI, the bulk of the improvement has been driven by increased bank capital.Change was minimal from the last quarter, however, the year-over-year increasewas strong. In the second half of 2011, the HFI fell from 1.24 to 1.15 as financialstress jumped and capital levels dipped. Since that time, financial stress hasdecreased and the Tier One Common Capital ratio surged to over 12.6 percent,bringing both the third and fourth quarter readings of the HFI to 1.28 in 2012.These changes represent stark improvements in the safety and soundness of thefinancial sector from before the crisis to today.
Methodology
The HFI is measured by using two commonly accepted metrics:1.
 
The Tier 1 Common Capital Ratio
for commercial banks measures financialinstitutions’ ability to absorb unexpected losses in an adverse environment.
Exhibit
!
1
!
The HFI Is 28% Above Historically Normal Levels In Q4’12, AnAll-Time High
!
Source: FDIC, SNL Financial, HPS Insight
!
0.481.151.281.000.40.50.60.70.80.91.01.11.21.3
+28%
!
   I  n   d  e  x   V  a   l  u  e   1   9   9   4   1   9   9   5   1   9   9   6   1   9   9   7   1   9   9   8   1   9   9   9   2   0   0   0   2   0   0   1   2   0   0   2   2   0   0   3   2   0   0   4   2   0   0   5   2   0   0   6   2   0   0   7   2   0   0   8   2   0   0   9   2   0   1   0   2   0   1   1   2   0   1   2
The Hamilton Financial Index
!
 
Hamilton Place Strategies | 3
2.
 
The St. Louis Federal Reserve Financial Stress Index
captures 18 marketindicators and is a well-established indicator of financial stress.The index value is the difference between the quarterly averages of the FederalReserve of St. Louis Financial Stress Index and the quarterly Tier 1 Common CapitalRatio for the banking industry. All data points are indexed to 1994 levels and 1.00 is the historical norm from 1994 to the present.
Capital Improvements Have Driven Increases in the HFI
The Tier 1 Common Capital Ratio is calculated by taking the industry's Tier 1Common Capital and placing it in proportion to the industry's Risk-WeightedAssets. The equation reads:
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 The U.S. commercial banking industry’s capital ratio is 12.6 percent as of the fourthquarter of 2012. Year-over-year, the ratio increased 1.3 percent. Since financialstress hit its crisis-era peak, the ratio has increased 32.4 percent, placing the industry on much firmer ground and in a significantly better position to handle unexpectedlosses (Exhibit 2).
Exhibit
!
2
!
Tier 1 Common Risk-based Ratio Dipped Slightly In Q4’12 ButRemains Well Above Pre-crisis Levels
!
Source: FDIC, SNL Financial
!
0.00.20.40.60.81.01.278910111213
   2   0   0   5   2   0   0   4   2   0   0   3
+32%
!
i   e C  omm on C  a  pi   t   a l    (   $  )  
   T   i  e  r   1   C  o  m  m  o  n   C  a  p   i   t  a   l    R  a   t   i  o   (   %   )   2   0   0   9   2   0   1   0   2   0   0   6   2   0   1   1   2   0   1   2   2   0   0   7   2   0   0   8
Tier 1 Common Capital
!
Tier 1 Common Capital Ratio
!
Tier 1 Common Capital and Tier 1 Common CapitalRatio for U.S. Banks
!

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