Capital Adequacy

Question 1

What is key for industry regulators?

Answer 1

That the firms are prudently managed
Aim is to protect their customers, firms and the economy through rules and principles - for continuation of safe and efficient markets able to withstand any foreseeable problems

Question 2

Where does the money a bank lends, come from?

Answer 2

Depositors money (customers save with a bank, the bank then lend the money to other customers)
Shareholders funds (shareholders original investment plus any retained profits)
Also banks borrow from the money markets in order to lend to others
- Note the money lent becomes part of the banks assets

Question 3

What is the critical challenge for banks?

Answer 3

• How much capital to set aside.
• Too little and they face a greater risk of failure
• Too much and they miss the opportunity to make good use of the capital for investment and further lending

Question 4

What is the result for national economies of a bank failing?

Answer 4

• It can be of a huge cost to the government and too much prevents lending and slows growth
• The correct amount of budgeting ensures that banks can withstand unexpected losses in a recessionary or downturning environment

Question 5

What are the regulations about capital adequacy?

Answer 5

• Broadly state that institutions must have sufficient capital to make it very unlikely that deposits will be placed at risk

Question 6

What is expected for the shareholders when looking at minimum requirements for capital adequacy?

Answer 6

They are expected to accept some risks whereas deposit money should not be at risk