Bank Capital
Bank capital refers to the financial cushion that banks maintain to absorb potential losses. It represents the difference between a bank's assets and liabilities and serves as a measure of the bank's financial strength and stability. Adequate bank capital is essential for protecting depositors and maintaining confidence in the banking system.
7 Key excerpts on "Bank Capital"
eBook - ePubThe Bank Credit Analysis Handbook
A Guide for Analysts, Bankers and Investors
- Jonathan Golin, Philippe Delhaise(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...Those other components exist, without which the market capitalization of a bank would just be equal to its equity, which is seldom the case. A bank as a going concern has an explicit forecast period value and a long-term continuing value that are taken into account formally in valuation estimates and informally in share prices. The regulator should, of course, be conservative and should disregard the contribution of anything that may disappear if the bank runs into financial difficulties. THE FUNCTION AND IMPORTANCE OF CAPITAL The primary function of capital is to support the bank’s operations, act as a cushion to absorb unanticipated losses and declines in asset values that could otherwise cause a bank to fail, and provide protection to uninsured depositors and debt holders in the event of liquidation. —U.S. Federal Reserve 8 Although there are differences in views concerning the weight that capital ratios should be accorded relative to other metrics—and concerning the best way to measure capital—as indicated towards the conclusion of the preceding introduction, there is no denying that the level of capital backing a bank can count on is almost universally a significant indicator of its financial health. Certainly, capital is a vital sign of bank financial strength. 9 But what makes it so? Why Capital Is Important The Functions of Capital Consider first the purpose of capital. As noted in Bank Director Basics, a publication of the U.S. Federal Reserve Bank intended to educate nonexecutive bank directors, “[b]ank capital serves the same purposes as capital in any other business.” It is important to banks for the same reason it is important to any firm. By providing the wherewithal to establish the enterprise in the first place, and over time, supplying the funds to expand, add new business lines, and invest in technology, it facilitates the bank’s creation and its subsequent investment and growth...
eBook - ePubBank Investing
A Practitioner's Field Guide
- Suhail Chandy, Weison Ding(Authors)
- 2021(Publication Date)
- Wiley(Publisher)
...CHAPTER 3 Capital “An essential message of the M & M Propositions as applied to banking, in sum is that you cannot hope to lever up a sow's ear into a silk purse. You may think you can during the good times; but you will give it all back and more when the bad times roll around.” – Merton H. Miller, Journal of Banking and Finance, 1995 CAPITAL FOR A Bank Capital serves as a cushion that allows a bank to absorb losses. The assets of a bank, namely the loans made and securities held, carry risk. Specifically, the loans may not be repaid, and the securities may fall in value. Regulators therefore require that a certain portion of these assets be supported by capital to protect depositors. Regulators, given the desire to protect depositors, are likely to want higher capital levels. Equity investors would be more desirous of an optimal capital level which is high enough to support growth and assuage regulators and yet be low enough to allow for an adequate return on capital. The protection that capital affords comes in different forms. Apart from common equity, preferred stock and subordinated debt are also counted as different types of capital. Likewise, there are many different capital and leverage ratios that bank investors can use in their capital adequacy analysis. We are partial to using what is known as the TCE Ratio (Tangible Common Equity/Tangible Assets) as it is conservative, intuitive, and easily comparable between institutions. There is no obligation for repayment of equity and thus this permanent capital is therefore the last line of safety. Theoretically, from the perspective of a bank investor, the capital level should be the least amount allowed by regulation during normal times. During times of stress, having some excess capital will reduce the likelihood of a dilutive capital raise...
eBook - ePubAn Introduction to Banking
Liquidity Risk and Asset-Liability Management
- Moorad Choudhry(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...Typically, an institution is subject to the regulatory requirements of its domestic regulator, but it may also be subject to cross-border requirements such as the European Union’s capital adequacy directive. 1 A capital requirements scheme proposed by a committee of central banks acting under the auspices of the Bank for International Settlements (BIS) in 1988 has been adopted universally by banks around the world. These are known as the BIS regulatory requirements or the Basel capital ratios, from the town in Switzerland where the BIS is based. 2 Under the Basel requirements all cash and off-balance-sheet instruments in a bank’s portfolio are assigned a risk weighting, based on their perceived credit risk, which determines the minimum level of capital that must be set against them. A bank’s capital is, in its simplest form, the difference between the assets and liabilities on its balance sheet, and is the property of the bank’s owners. It may be used to meet any operating losses incurred by the bank, and if such losses exceed the amount of available capital then the bank will have difficulty in repaying liabilities, which may lead to bankruptcy. However, for regulatory purposes capital is defined differently; again, in its simplest form regulatory capital is comprised of those elements in a bank’s balance sheet that are eligible for inclusion in the calculation of capital ratios. The ratio required by a regulator will be that level deemed sufficient to protect the bank’s depositors. Regulatory capital includes equity, preference shares and subordinated debt, as well as general reserves. The common element of these items is that they are all loss absorbing, whether this is on an ongoing basis or in the event of liquidation...
eBook - ePubCredit Engineering for Bankers
A Practical Guide for Bank Lending
- Morton Glantz, Johnathan Mun(Authors)
- 2010(Publication Date)
- Academic Press(Publisher)
...Ratios 330 Capital Adequacy: Establishing a Technical Framework 331 Functions of Bank Capital “Capital is an important indicator of a bank’s overall condition, for financial markets, depositors, and bank regulators.” 1 Bank Capital fosters public confidence and provides a buffer for contingencies involving large losses, thus protecting depositors from failure. Capital funds provide time to (1) recover so losses can be absorbed out of future earnings rather than capital funds, (2) wind down operations without disrupting other businesses, and (3) ensure public confidence that the bank has positioned itself to withstand the new hardship placed on it. Here are some additional points concerning the functions and growth of Bank Capital: Banks utilize much higher financial leverage than almost any other industry. Equity capital accounts for about 7% of total capital. Capital rules foster confidence. Capital must be sufficient to protect against on- or off-balance sheet risks. Minimum capital standards are vital to reducing systemic risk. Bank Capital reduces risks borne by the Federal Deposit Insurance Corporation (FDIC). Adequate capital allows absorption of losses out of future earnings rather than capital funds. Regulatory functions that ensure banks comply with capital requirements. Other functions include supplying the working tools of the enterprise. Perhaps the most important function of Bank Capital is providing protection against risks: Banks must be able to demonstrate that chosen internal capital targets are well founded and these targets are consistent with the bank’s overall risk profile and its current operating environment. In assessing capital adequacy, bank management needs to be mindful of the particular stage of the business cycle in which the bank is operating. Rigorous, forward-looking stress testing that identifies possible events or changes in market conditions that could adversely impact the bank should be performed...
eBook - ePubThe Money Markets Handbook
A Practitioner's Guide
- Moorad Choudhry(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...These are known as the BIS regulatory requirements or the Basel capital ratios, from the town in Switzerland where the BIS is based. 2 Under the Basel requirements all cash and off-balance sheet instruments in a bank’s portfolio are assigned a risk weighting, based on their perceived credit risk, that determines the minimum level of capital that must be set against them. A bank’s capital is, in its simplest form, the difference between assets and liabilities on its balance sheet, and is the property of the bank’s owners. It may be used to meet any operating losses incurred by the bank, and if such losses exceeded the amount of available capital then the bank would have difficulty in repaying liabilities, which may lead to bankruptcy. However for regulatory purposes capital is defined differently; again in its simplest form regulatory capital is comprised of those elements in a bank’s balance sheet that are eligible for inclusion in the calculation of capital ratios. The ratio required by a regulator will be that level deemed sufficient to protect the bank’s depositors. Regulatory capital includes equity, preference shares and subordinated debt, as well as the general reserves. The common element of these items is that they are all loss-absorbing, whether this is on an ongoing or basis or in the event of liquidation. This is crucial to regulators, who are concerned that depositors and senior creditors are repaid in full in the event of bankruptcy. The Basel rules on regulatory capital originated in the 1980s, when there were widespread concerns that a number of large banks with cross-border business were operating with insufficient capital. The regulatory authorities of the G-10 group of countries established the Basel Committee on Banking Supervision. The Basel Committee on Banking Supervision’s 1988 paper, International Convergence of Capital Measurement and Capital Standards, set proposals that were adopted by regulators around the world as the “Basel rules”...
eBook - ePubFinancial Stability and Central Banks
A Global Perspective
- Richard Brearley, Juliette Healey, Peter J N Sinclair, Charles Goodhart, David T. Llewellyn, Chang Shu, Richard Brearley, Juliette Healey, Peter J N Sinclair, Charles Goodhart, David T. Llewellyn, Chang Shu(Authors)
- 2001(Publication Date)
- Routledge(Publisher)
...The bank could be closed down as soon as its liabilities threatened to exceed the value of its assets. But, of course, none of these conditions holds in practice. Some risks, such as a change in a country’s fixed exchange rate, are jump risks that do not evolve smoothly. Extra capital is required to protect against such risks. Second, asset values are observed at discrete intervals. The greater the time between calculating the value of the bank’s assets and the more variable the value of those assets per unit of time, the more capital is needed to guard against changes in value during that interval. 27 This becomes particularly important if banks are led to engage in asset substitution as their capital diminishes. 28 Finally, capital provides a safeguard against errors in valuing the bank’s assets. Here also risk is likely to be relevant, for the higher an asset’s risk, the more likely that it will be misvalued. Thus there is a tradeoff between maintaining a high level of equity capital, and increasing the frequency and accuracy of asset valuations. 5.4.2 The Basel Accord While capital requirements have played an increasingly central role in bank regulation, the development of a well-defined standard is relatively recent. For example, for twenty years from the mid-1950s, US regulatory agencies employed an accounting formula for the desired amount of capital. Innovation in the 1960s and 1970s made this formula increasingly inappropriate and the agencies eventually reverted to a discretionary approach...
eBook - ePubCorporate Finance and Capital Structure
A Theoretical Introduction
- Kentaro Asai(Author)
- 2020(Publication Date)
- Routledge(Publisher)
...For example, capital regulations are often criticized for their reduction of liquidity provision (Diamond and Rajan, 2000) and bank lending (Thakor, 1996), as well as the crowding out of deposits (Gorton and Winton, 2017). Moreover, recent studies suggest that banks might bypass capital regulations (e.g., Kisin and Manela, 2016). If regulatory arbitrage is possible, capital regulations might encourage banks to shift their risky lending practices into shadow banking (Plantin, 2014) or simply shift investments into risky projects within the same asset class (Duchin and Sosyura, 2014). Nevertheless, some studies suggest the necessity of capital regulation. For example, Morrison and White (2005) find that capital regulation is an efficient tool enabling regulators to combat moral hazard and enhance screening outcomes. Mehran and Thakor (2011) show both theoretically and empirically that bank values are positively correlated with equity capital. The empirical and simulation results about the effects of capital requirements are also mixed. Opponents of capital regulation argue that it is costly for banks and society (e.g., Baker and Wurgler, 2015; Kisin and Manela, 2016; Van den Heuvel, 2008), reduces bank lending (Aiyar et al. 2014), and fails to reduce risk (Rime, 2001). Others find the effects of capital requirements are conditional. Berger and Bouwman (2009) test the relationship between capital and liquidity creation and find that it tends to be positive for large banks and negative for small ones. Others find that the effects of capital regulations depend on ownership structure (Laeven and Levine, 2009) or economic condition (Demirguc-Kunt et al., 2013). 8.6 Discussion The capital structure of a bank is distinct from a usual firm due to its role of providing liquidity to investors. Then, a bank is subject to a self-fulfilling financial crisis, because a bank run indeed occurs if investors believe that a bank would face a liquidity shortage...
