资本管理 chapter 10 bank management 5th edition. timothy w. koch and s. scott macdonald bank...
TRANSCRIPT
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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
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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
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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.
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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.
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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.'
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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.
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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
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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
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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
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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.
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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
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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.
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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.
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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
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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.
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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
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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%
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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
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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.
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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.
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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.
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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.
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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.
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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
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Example:TA / TA = EQ / EQ
Assume ROA=1.1%, 7% equity, DR=40%:
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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.
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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
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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
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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.
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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
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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.
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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.
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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!!
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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.
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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.
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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
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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.
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FDIC reserve ratios, fund balance, and insured deposits
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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
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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.
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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).
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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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%
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%
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%