TABLE OF CONTENT:
Introduction 2
Defining Bank Capital 2
Measure of Bank Capital
How Capital Absorbs Risk 2-4
• Covers Credit Risk
• Prevents Liquidity Problems
• Manages Operational Risk
• Restricts banks from taking excessive risk
Manipulation of Capital Standards 4-7
• Quality of Capital Resources
• Internal Rating Based (IRB) approach under Basel-II
• Securitization
• Credit Derivatives
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Capital in banks play an essential role of helping banks remain solvent by absorbing losses caused due to stress conditions. In this paper, we shall analyse how capital helps banks manage their risk, what led to banks failing during the financial crisis and what measures have been adopted to avoid (or better manage) such situations in future.
DEFINING BANK CAPITAL
Banks’ capital is defined to be the difference between the assets and liabilities of a bank.
It is the net worth of the bank or its value to investors. It is stated along the liabilities side of the balance sheet.
Main characteristics of bank capital
• No contractual repayment requirements: Unlike other liabilities, bank capital is perpetual. As long as bank continues to be in business, it is not obliged to repay the shareholders.
• Low priority in case of bankruptcy: In case of insolvency or bankruptcy, capital investors only receive what remains after paying all the creditors. Capital generally ranks low in case of claims as compared to most of the other claimants.
Constituents of bank capital
• Tier 1 Capital also known as core capital includes permanent shareholders’ equity and disclosed reserves.
• Tier 2 Capital (supplementary capital) includes undisclosed reserves, revaluation reserves, general provisions, hybrid capital instruments and subordinate term debt subject to certain conditions.
Capital is the source of fiancé through which resources are provided. It may be debt financing
Finding the perfect capital structure in terms of risk and reward can ensure a company meets shareholder expectations and protects a firm in times of recession. Capital structure refers to how a business puts its money to “work”. The two forms of capital structure are equity capital and debt capital. Both have their benefits and limitations. Striking that perfect balance between the two can mean the difference between thriving versus trying to survive.
True. I believe risk management has become one of the primary concerns for bank management. Banks deal with an overwhelmingly large number of exchange securities, for example, ( loans, treasury bills, forex trading, ect...) This causes bank managers to have skills to properly analyse and manage what securities they trade and what type of contracts they enter into, ( such as in hedging etc...). If banks do not shift their focus on such new financial instruments they might go bankrupt as a result of excessive risks in such securities. Hence the focus of bank supervision has shifted to risk management, rather than on capital requirements. Although both are key to running a successful bank.
The three types of capital mentioned in chapter 18 are, equity capital, economic capital, and regulatory capital. Equity capital, economic capital, and regulatory capital were established a capital standard for banks. Equity capital is defined as the book value of assets less the book value of liabilities. Furthermore, equity capital is also said to cushion debt and equity holders from unexpected losses. Regulatory capital includes the subordinated debt and some adjustments for off-balance sheet items. This is also different from economic capital, which is a statistical estimate of risk and capital, it also reflects the bank’s estimate of the amount of capital needed to support its risk-taking activities; it is not the amount of
The primary financial indicator is the roce which has shown an increases to 53.4 % in 2012 from 52.09 %. But, if the capital employed included the new £300m committed bank facility that yet drawn down at the financial reporting, then the roce show a fall to 42.07 %. The group might understate their long term liabilities.
If you are currently not a full time student, please briefly describe the activities you are participating in this academic year, if it is not listed on your AMCAS application.
The banking industry has undergone major upheaval in recent years, largely due to the lingering recessionary environment and increased regulatory environment. Many banks have failed in the face of such tough environmental conditions. These conditions
“When a financial firm’s capital is low, it is difficult for that firm to perform financial services; and when capital is low in the aggregate, it is not possible for other financial firms to step in and address the breach” (Richardson, (87).
In this essay I will be addressing the “Too Big To Fail” (TBTF) problem in the current banking system. I will be discussing the risks associated with this policy, and the real problems behind it. I will then examine some solutions that have been proposed to solve the “too big to fail” problem. The policy ‘too big to fail’ refers to the idea that a bank has become so large that its failure could cause a disastrous effect to the rest of the economy, and so the government will provide assistance, in the form of perhaps a bailout/oversee a merger, to prevent this from happening. This is to protect the creditors and allow the bank to continue operating. If a bank does fail then this could cause a domino effect throughout
We all know from our course that leverage and liquidity risks of financial institutions are vulnerable to the crisis. The financial crisis that emerged in 2007 had many and varied causes, but one of its most
This chapter is about the background of 2007-2008 financial crisis. The 2007-2008 financial crisis has a huge impact on US banking system and how the banks operate and how they are regulated after the financial turmoil. This financial crisis started with difficulty of rolling over asset backed commercial papers in the summer of 2007 due to uncertainty on the liquidity of mortgage backed securities and questions about the soundness of banks and non-bank financial institutes when interest rate continued to go up at a faster pace since 2004. In March 2008 the second wave of liquidity loss occurred after US government decided to bailout Bear Stearns and some commercial banks, then other financial institutions took it as a warning of financial difficulty of their peers. In the meantime banks started hoarding cash and reserve instead of lending out to fellow banks and corporations. The third wave of credit crunch which eventually brought down US financial system and spread over the globe was Lehman Brother’s bankruptcy in August 2008. Many major commercial banks in US held structured products and commercial papers of Lehman Brother, as a result, they suffered a great loss as Lehman Brother went into insolvency. This panic of bank insolvency caused loss of liquidity in both commercial paper market and inter-bank market. Still banks were reluctant to turn to US government or Federal Reserve as this kind of action might indicate delicacy of
Recent studies have investigated the impact of the 2007-2009 financial crises on banks’ capital. Berger and Bouwman (2011) emphasised the importance of capital during financial crisis. Their empirical study concludes that banks with solid capital base have some benefits during the crisis than those that are poorly capitalised. Well capitalised banks are more able to withstand the shocks due to liquidity squeeze, and therefore had higher chances of surviving the crisis period. Other benefits accrued to well capitalised banks include increase in their market share and profitability, as customers withdrew their funds from less capitalised to a well-capitalised banks. This conclusion was also reinforced by a recent empirical study conducted Olivier de Bandt et al (2014) on a sample of large French banks over a period of 1993 – 2012. Similarly, Gambacorta and Marques-Ibanez (2011) demonstrate the existence of structural changes during the period of financial crisis. They conclude that banks with weaker core capital positions, greater dependence on market funding and on non-interest sources of income restricted the loan supply more strongly during the crisis period. Using a multi-country panel of banks, Demirgüç-Kunt, Detragiache and Merrouche (2010) find among others results, that during
deducted from the list of liabilities plus the amount of capital. The positive difference is the net
Marginal Cost and Revenues well defined and the dynamics of pricing are initially defined well; the assumptions regarding elasticity are consistently applied, yet greater depth into variation of supply chain costs is needed to ensure a more complete view of elasticity and its variation over time.
Any profits remaining after deducting operating costs, interest payments, taxation, and dividend are reinvested in the business and regarded as part of the equity capital. The finance manager will monitor the long-term financial structure by examining the relationship between loan capital, where interest and loan repayments are contractually obligatory, and ordinary share capital, where dividend payment is at the discretion of directors. This is known as gearing. There are two basic types of gearing, they are capital gearing which indicates the proportion of debt capital in the firm’s overall capital structure; and income gearing indicates the extent to which the company’s income is pre-empted by prior interest charges. Both are indicators of financial gearing.