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Unformatted text preview: Chapter 9 Components of Components Bank Capital Bank
James B. Bexley, Chair Smith-Hutson Endowed Chair of Banking Sam Houston State University Huntsville, Texas 1 Regulatory Capital Adequacy
s Capital adequacy is & has been primary Capital concern of regulators for years. concern s Federal & state laws prescribe minimum Federal capital standards. capital s 10% Capital to deposit ratio was used up 10% until World War II as measure of adequacy. until s Since then, a capital to risk assets measure Since has been used. * has
2 Capital Planning In The Overall Financial Plan
s s Analyzing a bank’s performance. Predicting selected future key variables.
x x x Predict level of deposits. Predict level of loans. Predict other factors that limits progress. s s s Develop an overall projection from key variables. Sensitivity analysis & a range for the projections. Determining capital needs from projections. * Determining 3 Risk-Based Capital
s Core capital-Tier I (mininum 4%)
x Common tangible equity. x Perpetual preferred stock & qualified, mandatory Perpetual convertible debt up to 25%. convertible x Minority interest in equity of consolidated Minority subsidaries. * subsidaries. Continued 4 Risk-Based Capital Ratios
Core capital Tier I ratio = Risk-adjusted assets Total capital Tier II ratio = Risk-adjusted assets * 5 Risk-Based Capital (Continued)
s Total capital-Tier II limited to 100% of Tier I Total (minimum 8%) (minimum
x Nonspecific loan loss reserve up to 1.25% of risk Nonspecific adjusted assets (RAA). adjusted x Perpetual preferred stock not included in Tier I. x Mandatory convertible debt not included in Tier I. x Long-term subordinated debt--limited to 50% of Long-term Tier I & a phased-out straight line in last 5 years. Tier x Limited-life preferred stock--included with & Limited-life treated like long-term subordinated debt. * treated
6 Determining Capital Adequacy
s The purposes of bank capital s The advantages of leverage to owners. s Capital adequacy as measured by the Capital regulators. * regulators. 7 Four Functions of Bank Capital
s 1 Protect uninsured depositor in the event of Protect insolvency & liquidation. insolvency s Absorb unanticipated losses to keep the Absorb bank going & maintain confidence in it. bank s Acquire physical plant & other necessities Acquire needed to render banking services. needed s Serve as a regulatory constraint on Serve unjustified asset expansion. * unjustified
1Brenton C. Leavitt, Staff Member, Federal Reserve Bank. 8 Illustration of Capital Functions
Cash ABC Mfg. $50 XYZ Bank $100 Both ABC & XYZ have assets & liabilities of $1,000. Note the leverage by the bank of its capital. Note the difference of cash. Equity Capital ABC Mfg. $500 XYZ Bank $70 9 Ways to Increase Retained Earnings or Provide New Capital
s To increase retained earnings:
x Higher return on assets (what about risk?) x Lower dividend payout s To increase external capital:
x Issue new common stock x Issue new preferred stock x Issue subordinated notes or debentures *
10 Problems With Non-Risk Based Capital to Asset Ratio
s Off balance sheet activity was not subject to Off capital requirements (Ex. FNB-San Diego) capital s Banks with risky assets treated same as Banks bank with less risky assets. Fairness?? bank s Banks that moved into new activities that Banks had more risk than normal banking activities. * activities.
11 Capital Implications on Asset Growth
s Example Bank
x x x x x x $100MM Assets $94MM Liabilities $6MM Equity Capital Earned $1MM Net Inc. Paid $400M Dividends Adds $600M to Retained Adds Earnings Earnings Wants to grow & Wants stay at 6% Tier 1 stay Capital Capital Total Equity Capital Total now=$6.6MM which Would support $110MM in Assets $110MM ($6.6MM/.06=$110MM) 12 Risk Weights & Risk Categories for Risk-Adjusted Capital
Risk Category Onbalance sheet items No Risk Low Risk Moderate Risk Weight 0% 20% 50% General Description Vault cash & balances held with Fed, U.S. Govt. guaranteed loans, gold & direct claims on U. S. Tresury & U. S. Government agencies. Cash items in process of collection, short term claims on banks, g.o. municipal bonds, & claims fully secured with 0% to 20% risk assets. 14 family mortgages, credit equivalents of foreign exchange & interest rate contracts, Municipal revenue securities, & other securities where govt. is shareholder. Long term claims on U.S. & foreign banks, securities issued by foreign govts., fixed assets & all other assets typically found in banks. Standard Risk 100% 13 Risk Weights & Risk Categories for Risk-Adjusted Capital (Cont.)
Risk Category Offbalance sheet items No Risk Low Risk Moderate Risk Weight General Description 0% Unused portion of loan commitments with less than 1 year original maturity & unconditionally cancellable loan requiring credit decision on draw 20% Commercial letters of credit & other self liquiding trade related contingencies. 50% Transactionrelated contingencies such as a letter of credit backing nonfinancial performance, unused loan committments with greater than 1 year maturity, & revolving underwriting facilities, etc. 100% Direct credit substitutes, standby letters of credit, & assets sold with recourse. Standard Risk 14 Conventional v. Risk-Adjusted Capital Ratios
Asset Category No Risk Low Risk Moderate Risk Standard Risk OffBalance Sheet Risk Total Assets RiskWeighted Assets Conventional Amount $10,000,000 30,000,000 30,000,000 60,000,000 20,000,000 $150,000,000 Weight 0% 20% 50% 100% 100% RiskWeighted Amount $6,000,000 15,000,000 60,000,000 20,000,000 $101,000,000 0 We assume bank had $8,000.000 primary capital. Primary capital to total assets: $8MM/$150MM=5.33% Primary capital to riskadjusted assets: $8MM/$101MM=7.92% 15 7% Capital Start year with 7% capitaltoassets requirement: Assets $100MM Effects of Required Capital Levels on Internally Financed Growth
Deposits & borrowings: Capital (7%) $93MM 7MM $106.3MM 8.0MM End year with same capital requirement, $1 retained earnings: Assets $114.3MM Deposits & borrowings: Capital (7%) 6% Capital Start year with 6% capitaltoassets requirement: Assets $100MM End year with same capital requirement, $1 retained earnings: Assets $116.7MM Deposits & borrowings: Capital (6%) 7% Capital Drops to 6% Capital Start year with 7% capitaltoassets requirement: Assets $100MM End year with 6% capital requirement, $1 retained earnings: Assets $133MM Deposits & borrowings: Capital (6%) $94MM 6MM $109.7MM 7.0MM Deposits & borrowings: Capital (7%) Deposits & borrowings: Capital (6%) $93MM 7MM $125.3MM 8.0MM 16 Minimum Capital Requirements
Category Well Capitalized Adequately Capitalized Undercapitalized Significantly Undercapitalized Critically Undercapitalized Total Risk Based Ratio >10% >8% <8% <6% <6% & & or or or Tier 1 Risk Based Ratio >6% >4% <4% <3% <3% & & or or or Tier 1 Leverage Ratio >5% >4% <4% <3% <3% Capital Directive/ Requirement None Does not meet the definition of well capitalized bank 17 Implications of Risk-Based Capital Requirements
s Asset composition can change s Asset growth can slow s Price of off-balance sheet activities & loans Price can increase can s Structure of products & services can be Structure modified to meet lower risk classifications modified s Banks can seek additional capital via Banks mergers & acquisitions * mergers
18 Provisions For Prompt Corrective Action Under FDICIA
Category Well Capitalized Adequately Capitalized Undercapitalized Mandatory Provisions None No brokered deposits w/o approval Suspend dividends & mgt. fees Require capital restoration plan Restrict asset growth Approval required for acquisitions, branching, & new activities No brokered deposits Same as undercapitalized plus: Order recapitalization Restrict interaffiliate transactions Restrict deposit interest rates Pay of officers restricted Same as significantly undercapitalized Receiver/conservator within 90 days Discretionary Provisions None None Order recapitalization Restrict interaffiliate transactions Restrict deposit interest rates Restrict certain other activities Any other action that would better carry out prompt corrective action Any undercapitalized action plus: Conservatorship or receivership if fails to submit or implement plan or recapitalize pursuant to order Any other action necessary to carry out prompt corrective action Significantly Undercapitalized Critically Undercapitalized 19 BASEL II Accord Regarding New Capital Requirements
s 2004 Basel Committee released summary of 2004 proposal to revise how bank minimum capital requirements are determined. capital s Primarily designed for large banks. s As of now the Basel II is no further along to As being universally adopted. being 20 Sources of New Capital
s Issue New Stock s Issue Long-term Subordinated Debt s Increase Retained Earnings s Trust Preferred Stock 21 Dealing With Excess Capital
s Increase asset growth s Acquire other banks Acquire s Increase dividend payouts s Repurchase own stock ** 22 ...
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This note was uploaded on 09/30/2010 for the course FIN 468 taught by Professor Bexley during the Fall '10 term at Sam Houston State University.
- Fall '10