Role of Bank Capital

1375 Words Sep 6th, 2008 6 Pages
Introduction
The main aim of this report is to identify the key roles played by bank capital in the banking business. This report briefly outlines the main functions of bank capital and takes a brief look at the benefits of bank capital to the bank and the banking industry. It is hoped that from reading this paper a general understanding of the roles of bank capital in the banking business can be gained.
Bank Capital
A bank's capital also known as equity is the margin by which creditors are covered if the bank's assets were liquidated. A bank must hold enough capital to protect lenders and depositors from losses and also allow the bank to meet its customer requirements. Banks must maintain capital levels equal with the amount of risks
…show more content…
Normally this risk can also be managed easily by hedging interest rate changes by the use of derivative instruments.
However unanticipated system wide shocks result in a greater demand for liquidity and are far more difficult to deal with. At such times significant liquidity demands emerge from both a banks asset and the liability side. Refinancing short-term debt in the money markets is liability related and off-balance-sheet exposures can unexpectedly come onto the assets side of the balance sheet. Therefore a bank must be prepared when there is a market wide scramble for liquidity and be able to manage funding challenges and unplanned asset expansions simultaneously by having sufficient bank capital.
Promote economic growth
A strongly capitalized banking sector also is better able to promote innovation, whether in the form of new products, new services or new distribution channels. Banks do not just hold capital to overcome distress, but also because it provides them with financial flexibility. Banks with a strong capital base can take advantage of growth opportunities. A strong banking sector made up of banks with strong capital bases, is better able to supply credit to businesses and fund investment