Bank Capital

5 Key excerpts on "Bank Capital"

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  Global Financial Development Report 2019/2020

  Bank Regulation and Supervision a Decade after the Global Financial Crisis

  • World Bank(Author)
  • 2020(Publication Date)
  • World Bank

    (Publisher)

  The chapter concludes with policy recommendations. DEFINITIONS AND FUNCTIONS OF Bank Capital In an economic sense, Bank Capital consists of the value of equity owned by sharehold-ers. Bank economic capital can be defined as the value of the equity of a bank that can withstand losses. It has the lowest priority if the bank liquidates. Although there are sev-eral types of equity instruments (for exam-ple, common stock, contributed capital, and retained earnings), equity consists mainly of the profits retained by a bank or obtained from selling shares to investors. However, measuring equity is not simple because its value depends on how all financial instru-ments and on– and off–balance sheet assets of banks are valued (Berger, Herring, and Szegö 1995). Equity measured by its book value reflects the assets and liabilities that a bank reports on its balance sheet, thereby ignoring most off–balance sheet items and providing a historical accounting value rather than a current one. Equity measured by its market value reflects the value of the bank according to the stock market. For this measure, however, the market may not have the information needed to accurately price all bank assets. 80 B A N K C A P I T A L R E G U L A T I O N GLOBAL FINANCIAL DEVELOPMENT REPORT 2019/2020 reserves, hybrid capital instruments, or sub-ordinated term debt—up to some limits (see box 3.1 for details). The denominator of the ratio, or the regulatory measure of risk expo-sure, corresponds to the assets of the bank, which can be unweighted or weighted by risk. In theory, weighting assets by risk requires banks to hold more capital against portfolio items with higher risk. In practice, however, measuring risk exposure is difficult. Several approaches that have been used only weakly reflect the actual risk of bank operations and It is important to distinguish bank eco-nomic capital from regulatory capital.

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  The Bank Credit Analysis Handbook

  A Guide for Analysts, Bankers and Investors

  • Jonathan Golin, Philippe Delhaise(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  The continued funding of bank assets through deposit liabilities or other obligations depends almost entirely upon the confidence on the part of the very same depositors and bond holders that their funds are safe and available. To paraphrase Bagehot, where there is no confidence, there is no bank worthy of the name. So the risk that this trust might be lost poses an enormous danger for banks. Should a bank’s assets become impaired—that is, should some of those to whom the bank has advanced loans miss payments on those loans or otherwise cause doubt to arise concerning whether or not payment will be made on time and in full—or, graver still, should a significant number of borrowers fail to fulfill their financial obligations to the bank—then the bank will either make less profit on those loans than expected or suffer a loss. The amount of the loss will depend, among other things, upon the scale of the default and any corresponding recovery from the borrowers in default.

  If a loss is incurred, it will either come out of other profits (directly, or indirectly through loan-loss reserves); or, if profits are insufficient, the losses will be deducted from capital. Since a modicum of capital is required to maintain confidence and sustain operations, any capital lost must be replenished out of future profits or, absent a crisis severe enough to engender an offer of government assistance, from the very same risk-averse shareholders mentioned.

  Capital as a Regulatory Standard

  A bank’s depositors and bondholders are not the only parties keeping a weather eye on its capital strength. Bank supervisors also watch capital ratios closely; that modicum of capital just mentioned is likely nowadays to represent an elaborately defined regulatory requirement. In addition to the discipline exercised by the market, banks must comply with minimum capital requirements imposed by regulators. These rules form a significant part of the regulator’s arsenal, together with the other prudential regulations to which banks are subject, and related enforcement powers. Since the early 1990s, minimum bank capital requirements have become more uniform and increasingly ubiquitous , to the extent that another function of capital exists that is specifically applicable to banks: regulatory compliance.

  Capital as an Organizing Principle

  Finally, another function of capital within the banking sector derives from developments in financial theory, notably the concept of economic capital discussed later in this chapter. Briefly put, the relative level of Bank Capital has come to be seen as an organizing principle with which to measure a bank’s capacity to respond to risk events. In this context, capital is not only a benchmark against which risk can be evaluated, but also the critical parameter within a framework that enables risk-adjusted performance to be measured, alternative business strategies to be compared, and investment and capital allocation decisions to be systematically made. This is the concept of economic capital that is discussed later in this chapter.

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  Managing Banking Risks

  • Eddie Cade(Author)
  • 1997(Publication Date)
  • Woodhead Publishing

    (Publisher)

  How 'well managed' and how 'ill 25 MANAGING BANKING RISKS 3.1 Economic equity capital: a historical perspective Equity capital (ordinary shares and reserves, or 'shareholders' funds') is the fundamental building block and the vital element in a bank's capital base: we shall come to subordinated loan capital and other elements later. How much equity capital does a bank need for the conduct of its business? The economic principle established in Chapter 1 is that equity capital exists to absorb unexpected loss - to the extent that 26 managed', and what about all the intermediate conditions? It is a truism that 'good management' is the key to everything, but who is to be the infallible judge and guarantor of management quality? Most banks are a mixture of good and not so good management and, as circumstances and top teams change, are managed better in some eras than in others; not that we can always tell the difference at the time. The admired banks of one decade so often fall from grace in the next. Bagehot wrote in an age when the concepts of probability distributions and standard deviations, expected and unexpected losses had not been formulated, and when attempts to link Bank Capital to the quantum of risk would have seemed a good deal more questionable. We have less excuse for the same scepticism today. To dismiss the place of capital in banking is tantamount to denying the rationale for risk capital in business generally: bankers are not so quick to accept such an outrageous piece of special pleading from their borrowing customers. The community similarly is entitled to a measure of protection from banks' follies and misfortunes: capital which makes only a partial contribution in insolvency is better than nothing, even if it is insufficient to save the bank. That said, it is important to keep things in perspective. A bank's primary risks are not taken care of solely by throwing more capital at them.

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  The Valuation of Financial Companies

  Tools and Techniques to Measure the Value of Banks, Insurance Companies and Other Financial Institutions

  • Mario Massari, Gianfranco Gianfrate, Laura Zanetti(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  The rationale behind regulating banks is that, because of their interconnectedness and the reliance that the national (and global) economies hold on banks, it is important for regula-tory actors to maintain control over the practices of these institutions. The main bank regulatory framework is international in nature and promoted via subsequent frameworks (so called Basel I, II, and III) by the Basel Committee on Banking Supervision. The first international regulatory capital accord, usually referred to as Basel I, came into effect in 1992, four years after its first publication in 1988. The logic underlying those rules was to link the amount of capital that banks were required to maintain to the risks of their assets: the higher the risks, the higher the capital to maintain. Another goal was to level the international playing field so 62 The Valuation of Financial Companies Assets Liabilities Equity Eligible regulatory capital RWA Intangibles Excess capital ∑ = n i Asset i × Risk Weight i 1 Minimum regulatory capital Additional buffer Optimal capital Figure 3.1 The optimal and excess capital estimation as to avoid regulatory competitiveness. In particular, at the time US banks were concerned about the unfair advantage Japanese banks had, as the latter competed with much lower capital to assets ratio. 1 The core principle of this framework was that regulatory capital had to be maintained over the minimum required level, namely 8% of the Risk-Weighted-Assets: 𝑅𝐶 ∑ 𝐴 𝑡 ⋅ 𝑅𝑊 𝑖 ≥ 8% (3.1) where R C is the regulatory capital, A i is the value of each asset i held by the bank, and RW i is the risk-weighted coefficient associated to asset i . The processes leading to the minimum and optimal capital estimations for a bank (and hence to the quantification of the excess capital, if any) are shown in Figure 3.1. The rest of this chapter is devoted to showing how each of these elements can be computed.

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  Fundamentals of Finance

  Investments, Corporate Finance, and Financial Institutions

  • Mustafa Akan, Arman Teksin Tevfik(Authors)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  They no longer needed to rely exclusively on checking and demand deposits. They now set goals for asset (growth) and then ac-quired funds (issuing liabilities) as they needed for new loans. Suppose ABC Bank has an attractive € 10m loan opportunity. It would take a long time to get € 10m in new de-posits. However, it could issue a € 10m CD or commercial paper to attract funds. Or suppose there is an unexpected deposit outflow. Banks can now use the in-terbank market to easily and efficiently acquire sufficient reserves. Important changes over the last 40 years in bank balance sheets are: – Negotiable CDs, bonds, and bank borrowing (interbank market) now account for a large percent of bank liabilities. – Checking deposits have declined in importance as a source of bank liabilities. – Increased alternatives and higher flexibility in liability management, have given banks higher flexibility to manage assets profitably. Banks have increased the percentage of assets held as loans. Capital Adequacy Management Bank Capital is a cushion that prevents bank failure. The higher the Bank Capital, the lower the return on equity. Let ’ s look at the following ratios: – Return on Assets (ROA)=Net Profits/Assets – Return on Equity (ROE)=Net Profits/Equity Capital – Equity Multiplier (EM)=Assets/Equity Capital – ROE=ROA × EM. As equity capital increases, equity multiplies and return on equity will decrease. A tradeoff between safety (high capital) and ROE should be sought. Banks also hold capi-tal to meet capital requirements. Strategies for managing capital are: – Sell or retire stock – Change dividends to change retained earnings – Change asset growth The role of capital is: – To cushion an unexpected loss – Maintain public confidence in the banking system – Protection for non-insured deposits and other liabilities 15.5 General Principles of Bank Management 333 The safety of deposits is of paramount importance from the point of view of bank regulators and depositors.

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