Subject 2:

Bank capital

CIOBU Stela
Assoc. Prof., Ph.D.
 CONTENT
1. Content and functions ofBank Capital
2. Structure of Bank Capital
3. Needs of Bank Capital
4. Bank required capital
5. Regulation of bank capital in Moldova
6. Ways to increase bank capital
 Bibliography
 Legea cu privire la Banca Naţională a Moldovei nr. 548-XIII din
21.07.1995.
 Law on the activity of banks no. 202 of 06 october 2017.
 BASNO, C.; DARDAC, N.; FLORICEL, C. Monedă. Credit. Bănci.
Bucureşti: Editura Didactică şi Pedagogică, R. A., 2003. 374 p.
 MANOLESCU, Gh. Monedă şi credit. Bucureşti: Editura Fundaţiei
"România de Mâine", 2003. 228 p.
 STOICA, V.; DIACONU, P. Bani şi credit: banii, teoriile monetare,
administrarea banilor şi politica monetară. Bucureşti : Editura
Economică, 2003. 535p.
 TURLIUC, V.; BOARIU, A.; STOICA, O. Monedă şi credit. Bucureşti:
Editura Economică, Bucureşti, 2005. 303 p.
 ЖУКОВ, Е.Ф.; МАКИМОВА, Л.М.; ПЕЧНИКОВ, А.В. и др. Деньги.
Кредит. Банки: учебник для вузов. 2.е изд., перераб. и доп. М.:
ЮНИТИ-ДАНА, 2003. 600 с.
 ЛАВРУШИН, O. И. Деньги. Кредит. Банки: учебник. 2-e изд.
Москва: Финансы и Статистика, 2004. 456c.
 ПОЛЯКА Г. Б. Финансы. Денежное обращение. Кредит. 2-e изд.
Москва: ЮНИТИ-ДАНА, 2004. 507с.
1. Content and
functions of
Bank Capital
 Type of bank resources
 Own resources - these resources are created
from the capital which is subscribed by the
shareholders. These resources are stable
resources. They guarantee the stability of the
bank. They guarantee the efficiency of the bank
activity.
 Attracted resources - Mainly deposits, issuing
of the bill of exchange, Lombard credits,
overnight credits, deposits certificates, all these
are temporary resources. They manly generate
risk.
 Concept of bank capital
 Bank capital is the difference between a bank's assets
and its liabilities, and it represents the net worth of
the bank or its equity value to investors.
 Basel I, Basel II, and Basel III standards provide a
definition of the regulatory bank capital that market
and banking regulators closely monitor.
 Bank capital is segmented into tiers with Tier 1 capital
the primary indicator of a bank's health.
 Creditors are interested in knowing a bank's bank
capital as it is the amount they will be covered by if the
bank were to liquidate its assets.
 Functions of bank capital
first place
capital provides a cushion against the risk of failure by
absorbing financial and operating losses until
management can address the bank's problems and
restore the institution's profitability.
 Functions of bank capital
Second
 capital provides the funds needed to get the bank
chartered, organized and operating before deposits
come flowing in

 a new bank needs starting up funding to acquire land,

build a new structure or lease space, equip its facilities,
and hire offers and staff even before opening day.
 Functions of bank capital
Third
 capital promotes public confidence in a bank and
reassures its creditors (including the depositors) of the
bank's financial strength.

 capital also must be strong enough to reassure

borrowers that the bank will be able to meet their
credit needs even if the economy turns down.
 Functions of bank capital
Fourth
 capital provides funds for the organization's growth and
the development of new services, programs, and facilities.

 when a bank grows, it needs additional capital to support

that growth and to accept the risks that come with offering
new services and building new facilities.

 An infusion of additional capital will permit a bank to

expand into larger quarters or building additional branch
offices in order to keep pace with its expanding market area
and follow its customers with convenient service offerings.
 Functions of bank capital
Finally
 capital serves as a regulator of bank growth, helping to
ensure that the individual bank's growth is held to a pace
that is sustainable in the long run.

 both the regulatory authorities and the financial markets

require that bank capital increase roughly inline with the
growth of loans and other risky bank assets.

 thus, the cushion to absorb losses is supposed to increase

along withy a banking institution's growing risk exposure.
2. Structure of
Bank Capital
 Structure of bank capital
 Common stock
measured by the par (face) value of
common equity shares outstanding, which pay a
variable return depending on whether the
bank's board of directors votes to pay a dividend.

 Preference share
measured by the par value of any shares outstanding
that promise to pay a fixed rate of return.
Preferred stock may be perpetual or have only limited
life.
 Structure of bank capital
 Share Premium
representing the excess amount above each share of stock's
par value paid in by the bank's shareholders.

 Undivided profits or Retained Earnings

representing the net earnings of the bank that have been
retained in the business rather than being paid out as
dividends.

 Equity reserves
representing funds set aside forcontingencies such as legal
action against the bank, aswell as providing a reserve
for dividends expected to be paid at not yet declared and a
sinking fund to retire stock or debt in the future.
 Structure of bank capital
 Subordinated debentures
representing long term debt capital contributed by out
side investor's whose claims against the bank legally
follow (i.e.', are subordinated to) the claims of
depositors.
These debt securities may carry a convertibility
feature, permitting their future exchange for shares of
bank stock.
Measuring the size of Bank Capital
 By book value
recorded at the value they contained on the day they
were acquired or issued and posted on the bank’s
books.

 Regulatory capital
as per the directives issued by the concerned
regulatory agency.

 Market value capital

 by multiplying number of
shares by current market price.
. Needs of Bank Capital
3
 Haw much Capital
does a bank need?
 The main function of a bank is to perform an
intermediation role.
 For this purpose banks mobilize deposits from savers and
deploys that fund towards investors.
 The nature and risks in both these elements are
completely different.
 There may be chances of default from borrower side,
whereas, banks can not default towards depositors.
 For this purpose, regulators require banks to have a good
base of capital.
 The main purpose of banks requiring to have capital is to
make sure that banks are able to return funds to the
borrower, even in case of their failure to receive funds from
the borrower.
 Haw much Capital
does a bank need?
 Initially, regulators thought if banks are required to have a
minimum paid up capital before they are licensed, that
would solve the problem.
 So everywhere, banks were prescribed to have a
minimum paid up capital before they were authorized to
start their operation.
 The deficiency in this approach is it fails to take into
account the volume of business banks were undertaking.
 The more volume of business, the more risks bank is
taking.
 Under this approach, banks were not required to have
more capital even in case where they have expanded their
business to a large extent.
 Haw much Capital
does a bank need?
 So the authorities started to link the required capital
with the volume of assets which banks were having.
 Because off balance sheet activities will not be
recorded in the balance sheet, banks were not required
to have capital for undertaking these off balance sheet
activities.
4. Bank required capital
 Bank required capital
 Basel 1 refers to the guidelines with regard to the
required capital banks must posses.

 They have been called Basel guidelines because they

are issued by BIS (Bank for International
Settlements) located at a Switzerland city by the name
of Basel.

 As per German language, this city is called Basle. So,

sometime this guideline is also called Basle guidelines.
 Tier I Capital
 Tier 1 capital includes CET1 plus other instruments that are
subordinated to subordinated debt, and have no fixed maturity, no
embedded incentive for redemption, and for which a bank can cancel
dividends or coupons at any time. Tier 1 capital consists of
shareholders' equity and retained earnings. Tier 1 capital is intended to
measure a bank's financial health and is used when a bank must absorb
losses without ceasing business operations.
 From a regulator’s point of view, bank capital (and Tier 1 capital in
particular) is the core measure of the financial strength of a bank.
 Tier 1 capital is the primary funding source of the bank. Typically, it
holds nearly all of the bank's accumulated funds. These funds are
generated specifically to support banks when losses are absorbed so
that regular business functions do not have to be shut down.
 Under Basel III, the minimum tier 1 capital ratio is 8.5%, which is
calculated by dividing the bank's tier 1 capital by its total risk-based
assets. For example, assume there is a bank with tier 1 capital of
$176.263 billion and risk-weighted assets worth $1.243 trillion. The
bank's tier 1 capital ratio for the period was $176.263 billion / $1.243
trillion = 14.18%, which meets the minimum Basel III requirement of
tier 1 capital of 8.5% and the total capital ratio of 10.5%.
 Tier 2 Capital
 Tier 2 capital consists of unsecured subordinated debt and
its stock surplus with an original maturity of fewer than
five years minus investments in non-consolidated financial
institution subsidiaries under certain circumstances. The
total regulatory capital is equal to the sum of Tier 1 and Tier
2 capital.
 Tier 2 capital includes revaluation reserves, hybrid capital
instruments, subordinated term debt, general loan-loss
reserves, and undisclosed reserves. Tier 2 capital is
supplementary capital because it is less reliable than tier 1
capital. Tier 2 capital is considered less reliable than Tier 1
capital because it is more difficult to accurately calculate
and is composed of assets that are more difficult
to liquidate.
 Under Basel III, the minimum total capital ratio is 10.5%,
there is not a specified requirement for tier 2 capital.
 Calculation of TRC
TOTAL REGULATORY CAPITAL =
TIER I CAPITAL + TIER II CAPITAL -
INTEREST EQUITIES IN OTHER
BANKS’ CAPITAL
 Calculation of TRC
Tier I Capital
Common outstanding shares
+ Preferred non-accrued outstanding shares with
unlimited
+ Surplus of capital
+ Retained earnings and reserve capital
- Minus the calculated amount but unreserved of
the allowances for asset losses and conditional
commitments
- Minus net intangible assets
= TOTAL Tier I Capital
 Calculation of TRC
Tier II Capital
Preferred accrued and partially accrued
outstanding shares with unfixed maturity
+ Surplus of capital
+ Subordinated debt with unfixed maturity
+ Subordinated debt and preferred shares with
maturity
- Minus the amount of Tier II Capital that
exceeds the amount of Tier I Capital
- = TOTAL Tier II Capital
 Basic principles of capital adequacy stipulated
by the Basel
 at least 8% of risk-adjusted assets must be held * in the
form of core capital (I + II rank capital);
 at least 50% of the bank's capital must be of Tier I capital;
 the rest of the bank's capital can be formed by Tier I
capital (additional capital);
 off-balance sheet items (guarantees, bills of exchange) are
taken into account;
 each country can establish and apply its own criteria for
the adequacy of capital, but the minimum level is the one
established by the Basel Convention.
 Risk-weighted assets
 Risk-weighted assets are used to determine the minimum
amount of capital that must be held by banks and other financial
institutions in order to reduce the risk of insolvency. The capital
requirement is based on a risk assessment for each type of bank
asset.
 For example, a loan that is secured by a letter of credit is
considered to be riskier and thus requires more capital than a
mortgage loan that is secured with collateral.

KEY TAKEAWAYS
 Basel III, a set of international banking regulations, sets the
guidelines around risk-weighted assets.
 Risk coefficients are determined based on the credit ratings of
certain types of bank assets.
 Loans backed with collateral are considered to be less risky than
others because the collateral is considered in addition to the
source of repayment when calculating an asset's risk.
 KEY TAKEAWAYS
 Basel III, a set of international banking regulations,
sets the guidelines around risk-weighted assets.
 Risk coefficients are determined based on the credit
ratings of certain types of bank assets.
 Loans backed with collateral are considered to be less
risky than others because the collateral is considered
in addition to the source of repayment when
calculating an asset's risk.
Risk weighted assets
5. Regulation of capital
in Moldova
 Regulation of capital in Moldova
 The Executive Board of the National Bank of Moldova (NBM) set rates
to be applied on the new macro-prudential instruments, adopted by
the NBM pursuant to the Law no. 202 of 06.10.2017 on banks’ activity
and the Regulation on bank capital buffers approved by the Decision
of the Executive Board of the NBM no.110 of 24.05.2018.
 Thus, in addition to the 10% minimum own funds requirement, banks
are required to maintain the Tier I own funds to meet the
requirements for the capital buffer, the countercyclical buffer, the
systemic risk buffer and, where appropriate, the shock buffer for other
systemically important institutions (the O-SII shock buffer) according
to the shock buffer rates, approved by the Decisions no.110 of
24.05.2018 and no.193 of 31.07.2018 of the Executive Board of the NBM:
 Capital buffers in RM ()1
 1. The capital conservation buffer shall equal 2,5 % of a bank’s
total exposures;
 2. The countercyclical buffer rate for loan exposures located in the
Republic of Moldova shall equal 0% of the banks' exposure to risk.
At the same time, banks should ensure adequate records of the
countercyclical buffer rates applied to countries where they may
have loan exposures;
 3.1. The systemic risk buffer rate for exposures located in the
Republic of Moldova shall equal 1% of the banks' exposure to risk.
 3.2. The systemic risk buffer rate for exposures located in the
Republic of Moldova shall be increased by 2 p.p. in the case of
banks, over 50% of the capital of which is collectively owned,
directly and/or indirectly, by persons meeting any of the following
criteria:
 Capital buffers in RM (2)
 a) they are not financial sector entities;
b) are residents/have headquarters in the states where requirements
for prudential supervision and regulation are not at least equivalent
to those applicable in the Republic of Moldova, as defined in the
regulatory acts of the National Bank of Moldova;
(c) are not subject to supervision by the banking or capital market
supervisory authorities of the respective countries.
The criteria listed in paragraph 3.2. shall not apply in the case of
direct and/or indirect holdings held in the share capital of banks by
the multilateral development banks, as defined in the regulatory acts
of the National Bank of Moldova.
 Capital buffers in RM (3)
 4. The shock buffer rate set for other systemically important
institutions (the O-SII shock buffer), for banks identified as O-
SII type companies in the Republic of Moldova shall be:
a) 0.75% for C.B. "MOLDOVA-AGROINDBANK" S.A.,
b) 0.50% for C.B. "VICTORIABANK" S.A. and C.B.
"Moldindconbank" S.A.,
c) 0,25% for C.B. "MOBIASBANCĂ - Groupe Societe Generale"
S.A.
 Given the above, the capital requirement for banks in the
Republic of Moldova will vary between 13.5% and 16.25%,
depending on the shareholder structure and the systemic
importance of the bank. Previously, the 16% capital
requirement was applied to all banks.
6. Ways to increase
bank capital
 Ways to increase bank capital
 One set of strategies targets the bank’s retained earnings. The bank
could seek to reduce the share of its profit it pays out in dividends… The
most direct way to do so would be by increasing the spread between the
interest rates it charges for loans and those it pays on its funding. Lending
spreads would rise across the system if all banks followed a similar
strategy…

 A second strategy is to issue new equity, such as through a rights issue to

existing shareholders, an equity offering on the open market or placing a
bloc of shares with an outside investor. This is likely to be the least
attractive option for bank shareholders…

 A third set of adjustment strategies involves changes to the asset side of

the bank’s balance sheet. The bank can run down its loan portfolio, or
sell assets outright, and use the proceeds of loan repayments or asset sales
to pay down debt. Less drastically, it can slow down lending growth…

 Finally, a bank can seek to reduce its risk-weighted assets by replacing

riskier (higher-weighted) loans with safer ones, or with government
securities.”
 Thank you very much!!!
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