Decoder: Capital Adequacy Requirement

Dan Grech Jan 23, 2009

Decoder: Capital Adequacy Requirement

Dan Grech Jan 23, 2009


Scott Jagow: We’ve bailed out the banks with little to show for it so far. We haven’t seen what we were supposed to see: an increase in lending. The burning question is, why? Four words: The Capital Adequacy Requirement. I think it’s time for another installment of the Marketplace Decoder. And I have just the guy to explain it to you: Marketplace’s Dan Grech.

Dan Grech: As a business reporter, I’ve got a bit of an edge. My dad, Jo Grech, works as a loan officer at Royal Bank America, a regional bank near Philadelphia. So whenever I come across an arcane financial term, he’s my go-to guy.

Dan Grech: Hey Dad, it’s Dan. Um, do you have a sec? I just had a quick favor to ask.

Jo Grech: Sure.

Dan Grech: Can you tell me what a Capital Adequacy Requirement is?

Jo Grech: Well, I’ll try. That basically is a minimum amount of capital that a bank must have in order to keep doing business or lending money.

It’s a kind of cushion. To protect investors if things go sour.

Jo Grech: Let’s say that you’re a bank and that you have $100 million in assets. And by assets I mean everything the bank owns, buildings, investments, cash, et cetera. So the Capital Adequacy Requirement for that bank would be 10 percent of the $100 million, or $10 million.

In other words, the value of the bank’s assets would be 10 percent more than the value of its liabilities, such as issued stock and borrowed money.

It’s not always 10 percent. The thickness of the cushion is determined by international agreement and enforced by federal regulators. The riskier the assets, the higher the percentage.

Jo Grech: Now let’s say that the bank makes lots of bad loans and bad investments. So as the losses pile up, the bank’s capital might dip below that $10 million floor. Does that help you?

Dan Grech: Well, yeah, but what happens next?

Jo Grech: Well, basically the bank stops lending.

He says that explains why many banks are getting billions in federal bailout money, but aren’t lending it out.

Jo Grech: They’re using that federal money to bulk up their capital reserves and get them back above that minimum.

My dad’s an opinionated guy. He couldn’t help but slip in his two cents.

Jo Grech: I have to say, as a banker, that it’s a good thing the TARP money is out there, because it has stabilized a lot of banks. It really has.

Thanks, Dad. Any chance you could help stabilize me with a little capital infusion?

I’m Dan Grech for Marketplace.

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