资本管理 chapter 10 bank management 5th edition. timothy w. koch and s. scott macdonald bank...

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资资资资 Chapter 10 Bank Management Bank Management, 5th edition. 5th edition. Timothy W. Koch and S. Scott Timothy W. Koch and S. Scott MacDonald MacDonald Copyright © 2003 by South-Western, a division of Thomson Learning

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  • Chapter 10Bank Management, 5th edition. Timothy W. Koch and S. Scott MacDonaldCopyright 2003 by South-Western, a division of Thomson Learning

  • Why worry about bank capital? capital reduces the risk of failure by acting as a cushion against losses and by providing access to financial markets to meet liquidity needs.

    While bank capital-to-asset ratios averaged near 20% at the turn of the century, comparable ratios today are closer to 8 percent.Historical Trends in Bank Capital-1.00%1.00%3.00%5.00%7.00%9.00%11.00%13.00%15.00%19351938194119441947195019531956195919621965196819711974197719801983198619891992199519982001YearTotal Capital to Total AssetsGrowth Rate in Total Capital

  • Risk-based capital standardsDuring the last half of the 1980s, for example, all U.S. banks were required to meet a 5.5% minimum primary capital requirement and a 6 percent minimum total capital requirement.Primary capital consisted of stockholders equity, perpetual preferred stock, mandatory convertible debt, and loan loss reserves.

  • The Basle agreementIn 1986, U.S. bank regulators proposed that U.S. banks be required to maintain capital that reflects the riskiness of bank assets.By 1988, the proposal had grown to include risk-based capital standards for banks in 12 industrialized nations according to the terms of the Basle Agreement.Regulations were fully in place by the end of 1992.

  • Terms of the Basle AgreementMinimum capital requirement is linked to its credit risk as determined by the composition of assets.Stockholders' equity is deemed to be the most critical type of capital.Minimum capital requirement increased to 8% for total capital.Capital requirements were approximately standardized between countries to 'Level the playing field.'

  • Risk-based elements of the planTo determine minimum capital requirements, bank managers follow a four-step process:Classify assets into one of four risk categories;Classify off-balance sheet commitments and guarantees into the appropriate risk categories;Multiply the dollar amount of assets in each risk category by the appropriate risk weight; this equals risk-weighted assets; andMultiply risk-weighted assets by the minimum capital percentages, currently either 4 percent or 8 percent.

  • Regional National Bank (RNB), risk-based capital

    RISKC_EX

    Regional National Bank (RNB)Risk

    AssetsRiskWeighted

    $ 1,000WeightAssets

    Category 1: Zero Percent

    Cash & reserve104,5250.00%0

    Trading Account8300.00%0

    U.S. Treasury & agency secs.45,8820.00%0

    Federal Reserve stock5,9160.00%0

    Total category 1157,1530

    Category 2: 20 percent

    Due form banks / in process303,61020.00%60,722

    Int. bearing Dep./F.F.S.497,62320.00%99,525

    Domestic dep. institutions38,17120.00%7,634

    Repurchase agrements (U.S. Treas & agency)329,30920.00%65,862

    U.S. Agencies (gov. sponsored)412,10020.00%82,420

    State & Muni's secured tax auth87,51520.00%17,503

    C.M.O. backed by agency secs.90,02020.00%18,004

    SBAs (govt. guaranteed portion)29,26620.00%5,853

    Other category 2 assets020.00%0

    Total category 21,787,614357,523

    Category 3: 50 percent

    C.M.O. backed by mtge loans10,00050.00%5,000

    State & Muni's / all other68,51450.00%34,257

    Real estate: 1-4 family324,42250.00%162,211

    Other category 3 assets050.00%0

    Total category 3402,936201,468

    Category 4: 100 percent

    Loans: comm/ag/inst/leases1,966,276100.00%1,966,276

    Real estate, all other388,456100.00%388,456

    Allowance credit loss(70,505)0.00%0

    Other investments168,519100.00%168,519

    Premises, eq. other assets194,400100.00%194,400

    Other category 4 assets0100.00%0

    Total category 42,647,1462,717,651

    Total Assets before Off-Balance Sheet4,994,8493,276,642

    Off-Balance Sheet Contingencies

    0% collateral category00.00%0

    20% collateral category020.00%0

    50% collateral category050.00%0

    100% collateral category473,365100.00%473,365

    Total Contingencies473,365473,365

    Total Assets and Contingencies5,468,2143,750,007

    Capital requirementsTotal AssetsCaptial %Risk Adjusted Assets

    Tier I @ 4%199,7944.00%150,000

    Total capital @ 8%399,5888.00%300,001

    Off Balance Sheet Conversions$ Amt.Credit Conversion FactorCredit Equilavent $ Amount

    Contingencies 100% conversion factor

    Direct Credit substitues165,905100.00%165,905

    Acquisition of participations in BA, direct credit substitutes0100.00%0

    Assets sold w/ recourse0100.00%0

    Futures & forward contracts50,000100.00%50,000

    Interest rate swaps75,000100.00%75,000

    Other 100% collateral category0100.00%0

    Total 100% collateral category290,905290,905

    Contingencies 50% conversion factor

    Transaction-related contingencies050.00%0

    Unused commitments > 1 year364,92050.00%182,460

    Revolving underwriting facilities (RUFs)050.00%0

    Other 50% collateral category050.00%0

    Total 50% collateral category364,920182,460

    Contingencies 20% conversion factor

    Short-term trade-related contingencies020.00%0

    Other 20% collateral category020.00%0

    Total 20% collateral category00

    Contingencies 0% conversion factor

    Loan commitments < 1 year00.00%0

    Other 0% collateral category0100.00%0

    Total 0% collateral category00

    &L&D / SSM&CThe Dryden Press items and derived items Copyright (c) 1999 by the Dryden Press&RRISC_EX / &P

  • Regional National Bank (RNB)Risk-based capital

    RISKC_EX

    Regional National Bank (RNB), Risk-Based Capital

    AssetsRisk WeightRisk Weighted Assets

    $ 1,000

    Category 1: Zero Percent

    Cash & reserve104,5250.00%0

    Trading Account8300.00%0

    U.S. Treasury & agency secs.45,8820.00%0

    Federal Reserve stock5,9160.00%0

    Total category 1157,1530

    Category 2: 20 percent

    Due form banks / in process303,61020.00%60,722

    Int. bearing Dep./F.F.S.497,62320.00%99,525

    Domestic dep. institutions38,17120.00%7,634

    Repurchase agreements (U.S. Treas & agency)329,30920.00%65,862

    U.S. Agencies (gov. sponsored)412,10020.00%82,420

    State & Muni's secured tax auth87,51520.00%17,503

    C.M.O. backed by agency secs.90,02020.00%18,004

    SBAs (govt. guaranteed portion)29,26620.00%5,853

    Other category 2 assets020.00%0

    Total category 21,787,614357,523

    Category 3: 50 percent

    C.M.O. backed by mtge loans10,00050.00%5,000

    State & Muni's / all other68,51450.00%34,257

    Real estate: 1-4 family324,42250.00%162,211

    Other category 3 assets050.00%0

    Total category 3402,936201,468

    Category 4: 100 percent

    Loans: comm/ag/inst/leases1,966,276100.00%1,966,276

    Real estate, all other388,456100.00%388,456

    Allowance for loan and lease losses(70,505)0.00%0

    Other investments168,519100.00%168,519

    Premises, eq. other assets194,400100.00%194,400

    Other category 4 assets0100.00%0

    Total category 42,647,1462,717,651

    Total Assets before Off-Balance Sheet4,994,8493,276,642

    Off-Balance Sheet Contingencies

    0% collateral category00.00%0

    20% collateral category020.00%0

    50% collateral category364,92050.00%182,460

    100% collateral category290,905100.00%290,905

    Total Contingencies655,825473,365

    Total Assets and Contingencies before allowance for loan and lease losses and ATR5,650,6743,750,007

    (2,152)(23,630)(94,135)

    Total Assets and Contingencies5,650,6743,747,855

    Capital requirementsTotal AssetsCapital %Risk Adjusted Assets

    Tier I @ 4%199,7944.00%149,91493,378

    Total capital @ 8%399,5888.00%299,828

    Off Balance Sheet Conversions$ Amt.Credit Conversion FactorCredit Equivalent $ Amount

    Contingencies 100% conversion factor

    Direct Credit substitutes165,905100.00%165,905

    Acquisition of participations in BA, direct credit substitutes0100.00%0

    Assets sold w/ recourse0100.00%0

    Futures & forward contracts50,000100.00%50,000

    Interest rate swaps75,000100.00%75,000

    Other 100% collateral category0100.00%0

    Total 100% collateral category290,905290,905

    Contingencies 50% conversion factor

    Transaction-related contingencies050.00%0

    Unused commitments > 1 year364,92050.00%182,460

    Revolving underwriting facilities (RUFs)050.00%0

    Other 50% collateral category050.00%0

    Total 50% collateral category364,920182,460

    Contingencies 20% conversion factor

    Short-term trade-related contingencies020.00%0

    Other 20% collateral category020.00%0

    Total 20% collateral category00

    Contingencies 0% conversion factor

    Loan commitments < 1 year00.00%0

    Other 0% collateral category0100.00%0

    Total 0% collateral category00

    &L&"Arial,Bold Italic"&8Bank Management &"Arial,Regular"Template: &F / SSM&R&"Arial,Regular"&8Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc. Page &P

  • Regional National Bank (RNB)Risk-based capital (continued)

    RISKC_EX

    Regional National Bank (RNB)1999Risk

    AssetsRiskWeighted

    $ 1,000WeightAssets

    Category 1: Zero Percent

    Cash & reserve104,5250.00%0

    Trading Account8300.00%0

    U.S. Treasury & agency secs.45,8820.00%0

    Federal Reserve stock5,9160.00%0

    Total category 1157,1530

    Category 2: 20 percent

    Due form banks / in process303,61020.00%60,722

    Int. bearing Dep./F.F.S.497,62320.00%99,525

    Domestic dep. institutions38,17120.00%7,634

    Repurchase agrements (U.S. Treas & agency)329,30920.00%65,862

    U.S. Agencies (gov. sponsored)412,10020.00%82,420

    State & Muni's secured tax auth87,51520.00%17,503

    C.M.O. backed by agency secs.90,02020.00%18,004

    SBAs (govt. guaranteed portion)29,26620.00%5,853

    Other category 2 assets020.00%0

    Total category 21,787,614357,523

    Category 3: 50 percent

    C.M.O. backed by mtge loans10,00050.00%5,000

    State & Muni's / all other68,51450.00%34,257

    Real estate: 1-4 family324,42250.00%162,211

    Other category 3 assets050.00%0

    Total category 3402,936201,468

    Category 4: 100 percent

    Loans: comm/ag/inst/leases1,966,276100.00%1,966,276

    Real estate, all other388,456100.00%388,456

    Allowance credit loss(70,505)0.00%0

    Other investments168,519100.00%168,519

    Premises, eq. other assets194,400100.00%194,400

    Other category 4 assets0100.00%0

    Total category 42,647,1462,717,651

    Total Assets before Off-Balance Sheet4,994,8493,276,642

    Off-Balance Sheet Contingencies

    0% collateral category00.00%0

    20% collateral category020.00%0

    50% collateral category050.00%0

    100% collateral category473,365100.00%473,365

    Total Contingencies473,365473,365

    Total Assets and Contingencies5,468,2143,750,007

    Capital requirementsTotal AssetsCaptial %Risk Adjusted Assets

    Tier I @ 4%199,7944.00%150,000

    Total capital @ 8%399,5888.00%300,001

    Off Balance Sheet Conversions$ Amt.Credit Conversion FactorCredit Equilavent $ Amount

    Contingencies 100% conversion factor

    Direct Credit substitues165,905100.00%165,905

    Acquisition of participations in BA, direct credit substitutes0100.00%0

    Assets sold w/ recourse0100.00%0

    Futures & forward contracts50,000100.00%50,000

    Interest rate swaps75,000100.00%75,000

    Other 100% collateral category0100.00%0

    Total 100% collateral category290,905290,905

    Contingencies 50% conversion factor

    Transaction-related contingencies050.00%0

    Unused commitments > 1 year364,92050.00%182,460

    Revolving underwriting facilities (RUFs)050.00%0

    Other 50% collateral category050.00%0

    Total 50% collateral category364,920182,460

    Contingencies 20% conversion factor

    Short-term trade-related contingencies020.00%0

    Other 20% collateral category020.00%0

    Total 20% collateral category00

    Contingencies 0% conversion factor

    Loan commitments < 1 year00.00%0

    Other 0% collateral category0100.00%0

    Total 0% collateral category00

    &L&D / SSM&CThe Dryden Press items and derived items Copyright (c) 1999 by the Dryden Press&RRISC_EX / &P

  • General descriptions of the four risk categories

    Asset Category

    Risk Weight

    EffectiveTotal CapitalRequirement

    Obligor, Collateral, or Guarantor of the Asset

    1

    0%

    0%

    Generally, direct obligations of the federal government; e.g., currency and coin, government securities, and unconditional government guaranteed claims. Also balances due or guaranteed by depository institutions.

    2

    20%

    1.6%

    Generally, indirect obligations of the federal government; e.g.; most federal agency securities, full faith and credit municipal securities, and domestic depository institutions. Also assets collaterlized by federal government obligations are generally included in this category; e.g., repurchase agreements (when Treasuries serve as collateral) and CMOs backed by government agency securities.

    3

    50%

    4%

    Generally, loans secured by one to four family properties and municipal bonds secured by revenues of a specific project (revenue bonds).

    4

    100%

    8%

    All other claims on private borrowers.

  • What constitutes bank capital?according to accounting definition, capital or net worth equals the cumulative value of assets minus the cumulative value of liabilities, and represents ownership interest in a firm.Total equity capital equals the sum of:common stock, Surplus, undivided profits and capital reserves, and net unrealized holding gains (losses) on available-for-sale securities and cumulative foreign currency translation adjustments, andperpetual preferred stock

  • Risk-based capital standards two measures of qualifying bank capitalTier 1 or core capital consists of (4%):common equity, qualifying perpetual preferred stock, and minority interest in consolidated subsidiaries, less intangible assets such as goodwill. Tier 2 capital or supplementary capital:allowance for loan loss reserves up to 1.25 percent of risk-weighted assets,preferred stock, and mandatory convertible debt.

  • Leverage capital ratiosRegulators are also concerned that a bank could acquire so many low-risk assets that risk-based capital requirements would be negligiblehence, regulators have also imposed a 3 percent leverage capital ratio, defined as:Tier 1 capital divided by total assets net of goodwill and disallowed intangible assets and deferred tax assets.This capital requirement was implemented to prevent banks from operating with little or no capital, even though risk-based standards might allow it.

  • Risk-based capital ratios for different-sized U.S. Commercial banks

    Asset Size

    Year

    < $100 Million

    $100 Million to $1 Billion

    $1 to $10 Billion

    > $10 Billion

    All Commercial Banks

    Number of Institutions Reporting

    2001

    4,486

    3,194

    320

    80

    8,080

    2000

    4,842

    3,078

    313

    82

    8,315

    1999

    5,156

    3,030

    318

    76

    8,580

    1997

    5,853

    2,922

    301

    66

    9,142

    1995

    6,658

    2,861

    346

    75

    9,940

    Equity capital ratio (%)

    2001

    10.9

    9.68

    9.76

    8.77

    9.09

    2000

    11.08

    9.6

    8.99

    8.05

    8.49

    1999

    10.68

    9.24

    9.09

    7.87

    8.37

    1997

    10.81

    9.62

    9.16

    7.58

    8.33

    1995

    10.42

    9.39

    8.57

    7.19

    8.11

    Return on equity (%)

    2001

    8.07

    12.24

    13.77

    13.43

    13.1

    Core capital (leverage) ratio (%)

    2001

    10.63

    9.17

    8.74

    7.23

    7.79

    Tier 1 risk-based capital ratio (%)

    2001

    15.87

    12.88

    11.83

    8.86

    9.9

    Total risk-based capital ratio (%)

    2001

    16.96

    14.06

    13.77

    12.16

    12.72

  • FDICIA and bank capital standardsEffective December 1991, Congress passed the Federal Deposit Insurance Improvement Act (FDICIA) with the intent of revising bank capital requirements to:emphasize the importance of capital andauthorize early regulatory intervention in problem institutions, andauthorized regulators to measure interest rate risk at banks and require additional capital when it is deemed excessive. A focal point of the Act was the system of prompt regulatory action, which divides banks into categories or zones according to their capital positions and mandates action when capital minimums are not met.

  • Five capital categories of FDICIA.Not subject to regulatory directives regarding capital:well-capitalized and adequately capitalized banks Subject to regulatory restrictions:Undercapitalized, significantly undercapitalized and critically undercapitalized

  • Capital categories under FDICA

    Total Risk- Based Ratio

    Tier 1 Risk- Based Ratio

    Tier 1 Leverage Ratio

    Capital Directive / Requirement

    Well capitalized

    10%

    &

    6%

    &

    5%

    Not subject to a capital directive to meet a specific level for any capital measure

    Adequately capitalized

    8%

    &

    4%

    &

    4%

    Does not meet the definition of well capitalized

    Undercapitalized

    < 8%

    or

    < 4%

    or

    < 4%

    Significantly undercapitalized

    < 6%

    or

    < 3%

    or

    < 3%

    Critically undercapitalized

    Ratio of tangible equity to total assets is ( 2%

  • Prompt regulatory action under FDICIA

    B.Provisions for Prompt Corrective Action

    Category

    Mandatory Provisions

    Discretionary Provisions

    Well capitalized

    None

    None

    Adequately capitalized

    1.No brokered deposits, except with FDIC approval

    None

    Undercapitalized

    1.Suspend dividends and management fees

    2Require capital restoration plan

    3.Restrict asset growth

    4.Approval required for acquisitions, branching, and new activities

    5.No brokered deposits

    Order recapitalization

    2.Restrict interaffiliate transactions

    3.Restrict deposit interest rates

    4.Restrict certain other activities

    5.Any other action that would better carry out prompt corrective action

    Significantly undercapitalized

    1.Same as for Category 3

    2.Order recapitalization

    3.Restrict interaffiliate transaction

    4.Restrict deposit interest rates

    5.Pay of officers restricted

    1.Any Zone 3 discretionary actions

    2.Conservatorship or receivership if fails to submit or implement plan or recapitalize pursuant to order

    3.Any other Zone 5 provision, if such action is necessary to carry out prompt corrective action

    Critically undercapitalized

    1.Same as for Category 4

    2.Receiver/conservator within 90 daysd

    3.Receiver if still in Category 5 four quarters after becoming critically undercapitalized

    4.Suspend payments on subordinated debtd

    5.Restrict certain other activities

  • Tier 3 capital requirements for market riskmany large banks have dramatically increased the size and activity of their trading accounts, resulting in greater exposure to market risk.Market risk is the risk of loss to the bank from fluctuations in interest rates, equity prices, foreign exchange rates, commodity prices, and exposure to specific risk associated with debt and equity positions in the banks trading portfolio. Market risk exposure is, therefore, a function of the volatility of these rates and prices and the corresponding sensitivity of the banks trading assets and liabilities.

  • Tier 3 capital requirements for market riskIn response to the FDICIA stipulation that regulators systematically measure and monitor a banks market risk position, risk-based capital standards require all banks with significant market risk to measure their market risk exposure and hold sufficient capital to mitigate this exposure. A bank is subject to the market risk capital guidelines if its consolidated trading activity, defined as the sum of trading assets and liabilities for the previous quarter, equals 10 percent or more of the banks total assets for the previous quarter, or $1 billion or more in total dollar value. Banks subject to the market risk capital guidelines must maintain an overall minimum 8 percent ratio of total qualifying capital to risk-weighted assets and market risk equivalent assets. Tier 3 capital allocated for market risk plus Tier 2 capital allocated for market risk are limited to 71.4 percent of a banks measure for market risk.

  • Value-at-riskMarket risk exposure is a function of the volatility of rates and prices and the corresponding sensitivity of the bank's trading assets and liabilities.The largest banks use a value-at-risk (VAR) based capital charge, estimated by using an internally generated risk measurement model.

  • The original Basel Accords approach to capital requirements was primarily based on credit risk.Although it set appropriate protections from a market- and credit-risk perspective, it did not address operational or other types of risk. Operational risk itself is not new to financial institutions. Its the first risk a bank must manage, even before making its first loan or executing its first trade. What is new is that by 2005, a banks regulatory capital needs could increase significantlyup to 20 percent of total risk-based capitalas a result of its exposure to operational risk.

  • The new BASEL capital accord (BASEL II) and operational riskThe events of September 11, 2001 tragically demonstrated the need for banks to protect themselves against operational risk to their systems and people. Starting in 2005, regulators will begin calculating bank capital according to the recently adopted Basel II Accord for capital adequacy. The new focus of Basel II is operational risk. The focus is on the optimum use of capital in the technology and business process operations areas of a financial institution. The Basel Committee defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events.

  • Functions of bank capitalProvides a cushion for firms to absorb losses and remain solvent.Provides ready access to financial markets, guards against liquidity problems.Constrains growth and limits risk-taking: TA / TA = EQ / EQ

  • Example:TA / TA = EQ / EQ

    Assume ROA=1.1%, 7% equity, DR=40%:

  • Weakness of the risk-based capital standardsThe current formal standards do not account for any risks other than credit risk, except for market risk at large banks with extensive trading operations. Book value of capital is not the most meaningful measure of soundness.

  • The effect of capital requirements on bank operating policies: limiting growth

    Sheet1

    Case 1Case 2Case 3Case 4

    RatioIntitial PositionInitial 8%Asset Growth12% Growth: ROA12% Growth: ROA12% Growth: External Capital

    Asset growth rate (percent)8.00%12.00%12.00%12.00%

    Asset size (millions of $)100.00108.00112.00112.00112.00

    ROA (percent)a0.99%1.43%0.99%0.99%

    Dividend payout rate (percent)40.00%40.00%13.42%40.00%

    Undivided Profits (millions of $)4.004.644.964.964.665

    Total capital less undivide profits (millions of $)4.004.004.004.004.295

    Total capital / total assets (percent)8.00%8.00%8.00%8.00%8.00%

    Sheet2

    Sheet3

  • Application of Equation 13.2

    Case 1:8% asset growth, dividend payout = 40%, and capital ratio = 8%. What is ROA?

    Case 2:12% asset growth, dividend payout = 40%, and capital ratio = 8%. What is required ROA to support the 12% asset growth?

    Case 3:ROA = 0.99%, 12% asset growth, and capital ratio = 8%. What is the required ( dividend payout to support the 12% asset growth?

    Case 4:ROA = 0.99%, 12% asset growth, capital ratio = 8%, and dividend payout = 40%. What is the required ( external capital to support the 12% asset growth?

    _1090151842.unknown

    _1090151853.unknown

    _1090470647.unknown

    _1090151833.unknown

  • External capital sourcesBanks that choose to expand more rapidly must obtain additional capital from external sources, a capability determined by asset size. Large banks tap the capital markets regularly, but small banks must pay a stiff premium to obtain capital, if it is available at all. Capital sources can be grouped into one of four categories: subordinated debt, common stock, preferred stock, or trust preferred stock and leases. Each carries advantages and disadvantages.

  • Subordinated debtDoes not qualify as Tier 1 or core capitalImposes an interest expense burden on the bank when earnings are low. Subordinated debt offers several advantages to banks. interest payments are tax-deductible, generates additional profits for shareholders as long as earnings before interest and taxes exceed interest payments.Subordinated debt also has shortcomings. interest and principal payments are mandatory, default if not paidmany issues require sinking funds

  • Common stockCommon stock is preferred by regulators as a source of external capital. It has no fixed maturity and thus represents a permanent source of funds. Dividend payments are discretionary, Losses can be charged against equity, not debt, so common stock better protects the FDIC.Common stock is not as attractive from the bank's perspective due to its high cost because: dividends are not tax-deductible, transactions costs on new issues exceed comparable costs on debt, and shareholders are sensitive to earnings dilution and possible loss of control in ownership.

  • Preferred stockPreferred stock is a form of equity in which investors' claims are senior to those of common stockholders. As with common stock, preferred stock pays nondeductible dividends One significant difference is that corporate investors in preferred stock pay taxes on only 20 percent of dividends. For this reason, institutional investors dominate the market. Most issues take the form of adjustable-rate perpetual stock.

  • Trust preferred stockTrust preferred stock is a hybrid form of equity capital at banks.It is attractive because it effectively pays dividends that are tax deductible.To issue the security, a bank establishes a trust company.The trust company sells preferred stock to investors and loans the proceeds of the issue to the bank.Interest on the loan equals dividends paid on preferred stock.The loan is tax deductible such that the bank deducts dividend payments.As a bonus, the preferred stock counts as Tier 1 capital!!

  • Capital planningCapital planning is part of the overall asset and liability management process.Bank management makes decisions regarding the amount of risk assumed in operations and potential returns. The amount and type of capital required is determined simultaneously with the expected composition of assets and liabilities and forecasts of income and expenses. The greater is assumed risk and asset growth, the greater is required capital.

  • Federal deposit insuranceThe Banking Act of 1933 established the FDIC and authorized federal insurance for bank deposits up to $2,500, today coverage stands at $100,000 per account.The initial objectives of deposit insurance were to prevent liquidity crises caused by large-scale deposit withdrawals and to protect depositors of modes means against a bank failure. The large number of failures in the late 1980s and early 1990s put pressure on the FDIC by slowly depleting the reserve fund.

  • By the late 1990s, the FDIC was well fundedFinancial Institution Reform, Recovery, and Enforcement Act of 1989 (FIRREA) authorized the issuance of bonds to finance the bailout of the FSLIC and provide resources to close problem thrifts. The Deposit Insurance Funds Act of 1996 (DIFA) was enacted on September 30, 1996 Included both a one-time assessment on SAIF deposits to capitalize the SAIF fund Required the repayment of the Financing Corporation (FICO) bonds Mandated the ultimate elimination of the BIF and SAIF funds by merging them into a new Deposit Insurance Fund

  • Risk-based deposit insuranceFDIC insurance premiums are assessed based on a Risk-Based Deposit Insurance system required by the FDIC Improvement Act of 1991 and adopted in September 1992.These premiums are reviewed semiannually by the FDIC to ensure that:premiums appropriately reflect the risks posed to the insurance funds and that fund reserve ratios are maintained at or above the target Designated Reserve Ratio (DRR) of 1.25 percent of insured deposits Deposit insurance premiums are assessed as basis points per one hundred dollars of insured deposits.

  • FDIC reserve ratios, fund balance, and insured deposits

  • At the beginning of 2002, over 93% of banks are listed in the lowest category and pay no FDIC insurance premiums.

    Supervisory Subgroups

    Capital Group

    A

    B

    C

    Well capitalized

    0 bp

    3 bp

    17 bp

    Adequately capitalized

    3 bp

    10 bp

    24 bp

    Undercapitalized

    10 bp

    24 bp

    27 bp

  • Problems with deposit insuranceGovernment backed deposit insurance provides for stability of the financial system by reducing or preventing banking panics and protecting the less sophisticated depositor but this come at a price.

  • Problems with deposit insuranceFirst, deposit insurance acts similarly to bank capital and is a substitute for some functions of bank capital. In noninsured industries, investors or depositors look to the companys capital as a safety net in the event of failure. All else equal, lower capital levels mean that the company must pay a risk premium to attract funds or they will find it very difficult if not impossible to borrow money. In banking, a large portion of borrowed funds come from insured depositors who do not look to the banks capital position in the event of default A large number of depositors, therefore, do not require a risk premium to be paid by the bank. Normal market discipline in which higher risk requires the bank to pay a risk premium does not apply to all providers of funds. In addition to insured depositors, many large banks are considered to be too-big-to-fail (TBTF).

  • Problems with deposit insurance Third, deposit insurance funds were always viewed as providing basic insurance coverage.Historicall, there were three fundamental problems with the pricing of deposit insurance. Premium levels were not sufficient to cover potential payouts. The FDIC and FSLIC were initially expected to establish reserves amounting to 5 percent of covered deposits funded by premiums. Unfortunately, actual reserves never exceeded two percent of insured deposits as Congress kept increasing coverage while insurance premiums remained constant. Regardless, deposit insurance coverage slowly increased from $15,000 per account per institution in 1966 to $20,000 in 1969, $40,000 in 1974, and $100,000 in 1980.

    The high rate of failures during the 1980s and the insurance funds demonstrate that premiums were inadequate.

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