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Bank capital has several functions. It promotes public confidence; it restricts unwarranted asset growth.
It protects the depositors, gives insurance funds, and absorbs the losses.
Capital allows institutions to operate in times of financial difficulties. It helps even those firms that operate lose or serve at the time when companies face adverse financial results.
Such capital assures the public, which an institution can provide even when losses have happened; this helps in enhancing confidence in the banking system and reducing liquidity concerns.
The FDIC is the primary organization responsible for protecting deposits and insurance funds. Bank examinations are conducted by its supervisory bodies that help it review bank policies, management qualifications, and performance to identify weaknesses that could hinder earnings or capital.
The examiners handle the bank earnings, contingent liabilities, and capital effects that arise from banking relationships, trust activities, and litigations.
Bank regulatory capital is determined to limit risk and reduce the chance of losses.
The regulatory capital requirement helps the bank to absorb sufficient losses through shareholder's equity rather than from customer deposits or other sources.
These regulatory capital requirements are determined to ensure that the revenue or assets do not grow like the in-hand money. At the same time, one cannot assume the payout ratio for a given stock repurchase.
Financial companies issue loans to businesses and individuals; if those individuals and businesses default, the bank loses money.
The main forms of capital banks hold include Common equity CE Tier 1 capital, Tier 1 capital, and Tier 2 capital.
The Tier 1 Capital Ratio is calculated in asset management and investment banking by taking a ratio of the bank's core capital relative to risk-weighted assets.
The ratio was introduced in 2010 after the 2008 crisis to measure the bank's ability to handle financial distress.
The total capital is represented as a sum of Tier 1 and Tier 2 capital.
In 2010, the Basel Committee proposed a new standard for the two systems where the banks determine their tiers and capital ratio.
The banks with too much debt and low equity levels lack adequate capital to absorb the losses.
In 2013, the FDIC, OCC, and FRB issued regulations for insured depository institutions in the US aligned with the Basel III capital standards.
These standards were designed mainly to strengthen the quality and quantity of bank capital to promote strength in the financial industry to get asset classes' risk and return to make it resilient against economic stress.
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