Banking and the Management of Financial Institutions - General Principles of Bank Management - Capital adequacy management

6 important questions on Banking and the Management of Financial Institutions - General Principles of Bank Management - Capital adequacy management

Why do banks have to make decisions about the amount of capital they need to hold?

1. Bank capital helps prevent bank failure.
2. The amount of capital affects return for the owners (equity holders) of the bank.
3. Regulatory requirement

How does Bank Capital Help to Prevent Bank Failure?

Banks maintain bank capital to lessen the chance that it will become insolvent (when bank capital is negative)

How to know id the bank is managed well?

Measures of the profitability of the bank by measuring the return on assets or the return on equity
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What is the return on assets?

Net profit after taxes per dollar of assets

What is the equity multiplier?

Relationship between ROA and ROE, the amount of assets per dollar of equity capital

Pro's and cons of bank capital?

• Benefits to the owners of a bank by making their investment safe
• Costly to owners of a bank because the higher the bank capital, the lower the return on equity
• Choice depends on the state of the economy and levels of confidence

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