Contact us now Call: (302) 652-1100 Fax: (302) 652-1111
300 Delaware Ave., Suite 1300, Wilmington, Delaware 19801

BANK CAPITAL

The term “capital” is used in banking laws and regulations, but it does not appear on a bank’s balance sheet. However, the term “stockholders equity” does appear  on a balance sheet ,and is referred to as a component of core capital elements under bank capital  adequacy regulations. For purposes of these regulations, capital is divided into two categories, Tier 1 and tier 2, with stockholder’s equity falling into Tier 1. The regulatory capital requirements are risk weighted, meaning the amount of capital required  depends on the risks in the bank’s asset portfolio. Risk weights are assigned to the various asset categories. At one end of the spectrum, commercial loans have been assigned a 100% risk weight, and at the other end US Government securities have a zero risk weight.

Stockholders equity is derived from two principal sources, money originally invested in the bank, along with any additional investments and retained earnings. It is often calculated as a bank’s total assets minus total liabilities. A simple way of looking at capital is that it is money used by a bank in its operations that  does not have to be paid back The following quotes from a 2013 New York Times article by William Alden, titled “What is Bank Capital Anyway?” helps to clear up some common misconceptions. He commented “Though capital is a centerpiece of Wall Street Regulation, it resists simple definition ….Capital  is often described as a cushion that banks hold against losses. That is true, but the implications are not always clear. One unfortunate misconception that can arise is that capital is a rainy day fund. He offered the following explanation: “ To understand capital, think about how a financial firm does business. In a typical transaction, a firm pays for the investment with a combination of debt and equity, The more debt, or leverage that finances the transaction, the more money the firm can make (or lose)” He went on to point out that “By using debt, the firm can magnify the return it makes on equity. This is a principle banks use when determining how to finance their operations……More capital (so less debt) means that banks are able to withstand losses. But it also means they can’t make as much money. This dynamic – leading to lower returns – helps explain why banks tend to argue that holding capital is more expensive…..While capital provides a cushion against losses, they are unknown losses, in contrast to reserves, which relate to foreseeable losses.”

We hope the foregoing has provided you with a better understanding of the nature and purpose of bank capital.