Sunday, March 15, 2009

Understanding The Different Meanings Of Insolvency

A link to the Bronte Capital Blog on the different and many meanings of bank insolvency. It is an excellent discussion of insolvency. Much of the confusion in the public debate over bank insolvency has to do with the many meanings of the concept.

The following quotation from the Bronte Capital Blog explains the five types of insolvency.

"There are several definitions of solvency here – and it is not clear which definition people are using. Here is a list:

* Definition 1: Regulatory Solvency. Does the bank have adequate capital to meet the solvency tests imposed by regulators?

* Definition 2: Positive net worth under GAAP. Does the bank have positive net worth under GAAP accounting (ie yield to maturity with appropriate provisions when YTM is required or mark to market otherwise)?

* Definition 3: Positive economic value of an operating entity. If the bank is allowed to continue to operate it will be able to pay all its debt and replace its capital?

* Definition 4: Positive liquidation value. If you liquidated it today at current market prices it would have positive value.

* Definition 5: Liquidity. Does the bank have adequate liquidity to operate on a day to day basis?"

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