1 mcf 304: bank management lecture 3.1 bank’s capital management
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3 Bank’s Capital Management On the other hand, the management is more incline to use capital for maximum returns A huge capital base can reduce risks by absorbing income volatility, limiting growth opportunities and reducing the probability of failure However a huge capital base may also reduce the rate of return to shreholdersTRANSCRIPT
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MCF 304: Bank Management
Lecture 3.1Bank’s Capital Management
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Bank’s Capital Management
• Banks management and the regulatory body are different in their views on bank capital management (LP Dilemma)
• Regulatory body stipulates various rules such as capital diversification to ensure the security of deposits as well as bank’s stability
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Bank’s Capital Management
• On the other hand, the management is more incline to use capital for maximum returns
• A huge capital base can reduce risks by absorbing income volatility, limiting growth opportunities and reducing the probability of failure
• However a huge capital base may also reduce the rate of return to shreholders
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Bank’s Capital Management
• Bank’s capital can be define as asset minus liabilities and minus certain type of debts and reserves stipulated by regulatory body
• Debts and reserves are included in bank’s capital in order to ensure capacity adequacy of banks
• Bank’s core capital can be divided into Tier 1 & Tier 2
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Bank’s Capital Management
Bank’s Capital
Tier 1
Ordinary Shares
Contingency Reserves
Unappropriate Profits
Loan Loss Reserves
Capital Reserves
Preference Shares
Debentures Convertible Securities
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Characteristics of Bank Capital
• Ordinary shares• Preference shares• Unappropriated Profits• Capital Reserves• Contingency Reserves• Loan Loss Reserves• Debentures• Convertible Securities
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Function’s of Bank Capital
• Operational function• Protection function• Supervision function
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Characteristics of Bank Capital
Operational - Long term fund usually
consist of shareholder’s fund & long term debt
- Normally used to finance fixed assets
- Used as a measurement for opening new branch
Protection - Act as a loss absorber- Assurance to the general
public on the bank’s capability
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Function’s of Bank Capital
Supervision- Requirement by the central
bank- All financial institution must
have adequate capital base to be allowed to conduct business
- A capital base will help bank’s prevent “bank runs” situation when they incurred losses
- The banks capital must be able to absorb any losses and ensured the bank’s continued operations
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Example: ABC Bank
Assets
Cash 10Short term securities 20Loan & advances100Fixed assets 10
Total 140
Liabilities & Equities
Deposits 60Long term debts 10Capital 40Retained earnings 40
Total 140
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Example: ABC Bank
Assets
Cash 10Short term securities 20Loan & advances70Fixed assets 10
Total 110
Liabilities & Equities
Deposits 60Long term debts 10Capital 30Retained earnings 10
Total 110
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Example: ABC Bank
Assets
Cash 10Short term securities 20Loan & advances20Fixed assets 10
Total 60
Liabilities & Equities
Deposits 60Long term debts 10Capital (10)Retained earnings -
Total 60
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Example: ABC Bank
Assets
Cash 30Short term securities 20Loan & advances70Fixed assets 10
Total 80
Liabilities & Equities
Deposits 60Long term debts 10Capital 10Retained earnings -
Total 60
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Bank’s Capital Management
• Most of larger banks are able to raise external capital through capital market but smaller banks are only able to raise capital via internal funds in the forms of retained earnings
• Retained earnings however must be shared with shareholders in the form of dividend
• This is why statutory requirements are imposed
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Bank’s Capital Management
• This has forced banks to limit growth to a certain percentage of retained earnings plus fresh external capital.
• The minimum capital requirement had forced the bank to use external capital in the form of debts. Hence the change of minimum capital requirement will change the capital structure of a bank
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Bank’s Capital Management
• Banks which are unable to procure additional capital will tend to invest in low risk assets
• Bank that is able to procure additional funds to increase its capital base tends to invest in high risk assets to justify their investments
• The minimum capital requirement also influences the pricing policy of a bank
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Thank You!Izdihar Baharin @ Md Daud
Post Graduate CentreHP: 006019-5170817
Email: [email protected]