Exaggerated bank 'losses' in sub-prime crisis

ICICI Bank makes a provision of $265 mn against mark-to-market positions. The stock tanks- and so does the Sensex. Does this make sense?

I think not. There is huge overshooting of asset prices in panic conditions- that is, prices go well below "fair" value. Naturally, mark-to-market losses will be commensurately high. Once the market bounces back, these provisions will be written back.

We have it on the authority of Fed Chairman, Ben Bernanke, no less, that bank writedowns have been overdone in the present crisis. He said as much in his congressional testimony on February 28. How does this happen? Many of the assets are not traded. So marking to market is done using certain indices. These indices' movements don't correctly reflect actual losses. One analyst points out that one index shows an 8% potential loss in commercial real estate when the real loss has been one quarter of 1%. As the Yanks would say, the thing sucks.

There is a larger issue here: how do we enforce mark-to-market requirements in such crisis situations? As Gillian Tett points in the FT, "The western financial system is caught in a trap. On the one hand, there is an urgent need for clearing prices to be established for impaired assets to restore confidence; on the other hand, if this is done in a mark-to-market world, there is a risk that some banks will run out of capital."

One solution proposed is a six month grace period for marking to market. But this could undermine investor confidence- people won't know what sort of losses a bank is hiding. I can't see an easy way out. But I am glad we don't have mark-to-market requirements for bank loans although investment bankers have long demanded this in the interest of having a level playing field between investment banks and commercial banks. Can you imagine the havoc that could wreak in such conditions?

Coming back to ICICI Bank, the stock price is close to its last FPO price. If I were an analyst taking a long view, I would put a 'buy' recommendation.