The great repricing of risk has brought us to this point and volatility seems to be settling in at lower levels as well.
So where are we?
Due to funding risks, spreads are now at levels where they need to be to provide risk adjusted returns on capital for banks to approximately represent returns on capital needed for banks to attract that capital.
For example, if a bank obtain assets that earn 2% (after expenses) above it’s funding costs, and in today’s market regulators target a 12% tier one capital ratio, the return on capital is a little over 15%.
In the past, banks struggled to make this kind of spread as they were competing with non banks that could leverage higher than that, supported by investors willing to accept much lower risk adjusted returns, and also supported by banks willing to work for lower risk adjusted returns in their higher leverage off balance sheet entities.
Credit Graph Packet
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