ee Chapter - 6 G1 Iniroduction GET The Measures of Capital Adequacy oF a “6.2 Types of Capital Bank 6.3 _ Instruments of Raising Bank Capital 682 Test of Capital Adequacy of Bank (G4 importance of Bank Capital 6.9 Arrangement of Safety of Bank Capital 6.5 Functions of Bank Capital 6.10 Capital Adequacy of Banks in 66 Bank Capital Planning : Bangladesh 6.11 Conclusion 67 Bank Capital Planning Process 6.1 Introduction : : to perform preli Principally to funds contrit ‘camings that are retained in the bank". a liquidation of a bank is impossi tion of a bank, capital plays very important role. | 6.2 Types of CapitalCapital Management 4 Undistributeg Profit = i indatory convert Reserves 2 Ton nee stumeny debentures/bonds, Elements of secondary capital are 8 follows: 1. Limited life Preferred stock 2. Subordin 2 Su ubor hated notes and debenture HOry Convertible instrument not ‘Amount of weighted Classification of asset Amount en risky s(n 1. Cash and Central Govt, Debentue1 100 7 ae (Maturity less than 90 days) _ 2. Central Govt. Debenture. Gnaturiiy | 100s 10 =10 of above 90 days) | 3. State “& “regional Govt. General | 200% 2 = Debenture Govt revenue Debenture ta, we can calculate the necessary amount of capital, In the above table, necessary Spams era ginny figure fora bank. second ira t be -altemative are acceptable but third alternative cannot be 3, sa be treated as violators of the banking rules, and this a sver, regulatory authorities will treat the bank as a problemBank Management-A Fund Emphasis 88 thority will also summon a notice to the problem bank to increase the capital to bank. The regulatory authority : fain period. Within this duration, if the problem bank fails to change the ee 6.3 Instruments of Raising Bank Capital The instruments, used by new banks or existing banks for collecting capital, can be of two types: a) ‘ Equity based instruments b) Debt based instruments ; Exquity based capital raising instruments Features ~ 1. Common stock 2, Preferred stock 3. Convertible Preferred stock 4, Adjustible rate preferred stock 5. ESOP= Employee stock option plan 6. ESOTS= Employee stock option trusts elo for contmon welfare Debt based Capital raising instruments Features ‘Smaller denomination of maturity from 7 tols ‘years Residual but unlimited claim Fixed rate of dividend Convertible into common stock Dividend adjusted with profit volume Distributed to the employees for individual gains Distributed to the employees for common welfare T-Capital Notes 2. Capital Debenture 3, Convertible Debt 4. Variable Rate Debt 5. Option rate Debi Leasing Arrangement Larger denomination of maturity from 15 years and above Convertible to common stock Changeable interest rate Convertible into fixed rate debt Sales and lease back difficulty pital to theCapital Management 89 ry act as a cushion in times of restricted monetary policy (i.e. when bank rate increases etc.) ‘0 raise awareness that bank owners have stake along with the depositors in the supply of loanable funds 5. To obtain permission for opening new branches, and i 6, Toavoid punitive measures by the regulatory agency for reasons of capital inadequacy 4. In the following section, the above mentioned points are discussed briefly: J. To create & maintain public confidence: Both the existing and potential depositors are ~ interested to those banks which own adequate volume of capital.-The depositors bear relatively less tisk when the bank has at its command adequate volume of capital. Thus, adequacy of capital increases the bank deposits creating & maintaining confidence of the existing and potential depositors. 2. To provide for normal hazards and unforeseen contingencies: Banks may face unforeseen contingencies and financial risks in their day-to- day business. Adequate capital helps bank to ‘overcome unforeseen contingencies as well as losses arisen from bad debt, non-performing customers and irresponsible employees, ete. - To act as a cushion in times of restricted monetary policy (i.e. increase bank rate ete,): The shortage of loanable funds arises when the government takes any Kind of restrictive monetary ‘policy. Providing loans according to the policy and target of the bank are crucial for its goodwill & income. On the other hand, restricted monetary policy in the time of disbursing previously granted loan commitments adversely affects the loan activities of the bank. Banks may be embarrassed to existing and potential loan clients in such a case. To avoid this type of situations, banks should @ funds: Bank depositors often think that the bank is operating the business by using ‘only ited money. This presumption should not be correct if adequate capital is raised. To ¢ the risk, deposit insurance schemes and statutory laws to maintain minimum required ital have been enacted. on for opening new branches: ‘The banking regulatory authority takes the ‘as the basis for expansion of the banking activities and establishing new tasset ratio passes within the control limit when a bank operates with adequate the banking business in a balanced order. So, before expanding the operation iber of: branches, the desired level of bank capital must be maintained. ‘body may refuse to give license to increase the number of branches. ures for reasons of capital inadequacy: Government or bank regulatory “the statement of bank and also conduct field investigation by their information about the financial condition and adequacy of capital of . rules & regulations or any guidelines, then the bank is served regulatory bodies. Thus, to avoid such punitive actions and run ik has to maintain capital not less than as required by the« 90, Bank Management-A Fund Emphasis 5 Functions of Bank Capital Capita is very important Forte activites ofa bank The funtion of bank capital ate discussed below 25 4. 5 i ‘To acquire the physical plant and basic necessities needed to render Banking Services: Physical infrastructures like- office equipment, furniture, employees ete are requited (0 start a hanking business, Capital is inevitable to acquire these assets. The larger the amount of capita of a bank and the more attractive multistoried building a bank has, the more valued clients will be atcracted t0 it. To act as one of the sources of funds for loans and investments: The purpose of investment and Joan activities is to increase the income of the bank. Banks may mect up a portion of the loan and inyestment demand through raising capital. Though most of the loan and investment activities are ‘operated with the depositors’ money, sometimes bank operates this activity with its own capital, especially, at the preliminary phase of the banking business. To protect the uninsured depositors in the event of insolvency and liquidation: Recently, bank ‘regulatory authority has looked into through serving an order of deposit insurance to ensure the safety of the deposit. In times of bank liquidation or failure, deposits which are not insured need to be returned from the capital resources of the bank. To act as an unanticipated Loss Absorber: Hazards, business losses and unforeseen contingencies like bad-debt, misfeasance on the part of the employees when occur at any time may call for huge amount of money. Capital plays an important role to resolve such type of losses. To serve as a regulatory restraint: Govt. or bank regulatory authority provides the direction of the adequacy of bank capital and the amount of capital reserve. The bank regulatory authorities often inspect the bank to verify the level of capital maintained. If the bank fails to maintain the required level of capital, the regulatory authority takes legal as well as pecuniary punitive action against the bank. A bank can avoid this type of punitive action by maintaining sufficient amount of capital. According to legal requirement, total capital cannot be less than 8% of the weighted average risky assct and cquity capital can never be less than 4% of weighted average risky asset So, a bank needs to follow the statutory requirement to avoid difficulties likely to be faced in times of default. From the above analysis, we can say that from the inception to the liquidation, at every step, capital is very much important for a bank. Capital Planning Bank capital planning is a procedure of determining the capital levels and capital mix of 9 bank. In a broad sense, bank capital planning is a process of assessing total capital requirement for a particular time period and determining the portion of capital to be collected either from internal (owner's equity) or external (debt, borrowings) sources. In determining the structure of bank capital, top priority should te given in attaining the profit target and controlling the risk through minimizing the cost of collecting funds. This can be easily understood by the following diagram: