The capital adequacy ratio of banks highly regulated worldwide in order to better ensure the stability of the financial system and the global economy. It also provides additional protection for investors. In the United States, banks are regulated at the Federal level, the Federal Corporation on insurance of deposits (FDIC), Federal reserve system and the office of the Comptroller of the currency (OSS). In addition, state banks are subject to state regulation bodies. Regulation and the solvency of banks is considered critical because of the exceptional importance of the banking system for the functioning of the economy as a whole.
Monitoring the financial condition of banks is also important because banks have to deal with a mismatch in liquidity between assets and liabilities. On the liabilities side of Bank’s balance sheet is very liquid accounts such as demand deposits. However, the Bank’s assets mainly consist of fairly illiquid loans. While loans can be (and often are) sold in cans, but they can quickly be converted into cash by selling them at a substantial discount.
Assessment Of Capital Adequacy
The most commonly used assessment of Bank capital adequacy the capital adequacy ratio. However, many analysts and professionals in the banking industry prefer to measure economic capital. In addition, analysts or investors may look at tier 1 leverage ratio or liquidity ratios in the analysis of the financial condition of the Bank.
The Capital Adequacy Ratio
US banks are required to maintain a minimum capital adequacy ratio. The capital adequacy ratio represents the risk-weighted credit risk of the Bank.
The ratio of measures of two kinds of capital:
Some analysts are critical of the risk-weighting aspect of capital adequacy, indicating that most loan defaults that occurred during the financial crisis of 2008 was for loans is assigned a very low risk weighting, while many of the loans with the greatest weighting on the risk is not default.
1 Leverage Ratio Tier
The capital adequacy ratio associated sometimes considered a ratio of 1 level of the shoulder. The ratio of shoulder level 1-is the relationship between the main Bank’s capital to its total assets. It is calculated by dividing tier 1 capital by average total Bank assets and certain off-balance sheet items.
The higher the ratio shoulder 1 layer, the greater the chance that the Bank will be able to withstand negative shocks to their balance sheets.
The Measure Of Economic Capital
Many analysts and Bank executives believe the measure of economic capital to be more accurate and reliable assessment of the financial condition of the Bank reliability and risk than the level of capital adequacy.
The calculation of economic capital, which is calculated the amount of capital a Bank must have on hand to ensure its ability to cope with its current high risk based on the Bank’s financial condition, credit rating, expected loss and confidence level of solvency. Including such economic realities as the expected loss, this is a more realistic estimate of the Bank’s actual financial condition and level of risk.
The Liquidity Ratios
Investors and market analysts is also possible to check the banks using standard estimates of capital, which evaluate the financial condition of a company in any industry. These alternative metrics of evaluation include liquidity ratios such as current ratio, cash ratio and quick ratio.