Question

4. Bank regulators impose minimum capital adequacy standards on commercial banks. (a) Briefly explain the main functions of capital. (b) Identify and define the different types of acceptable capital under the Basel II.

Answer 1

The functions of capital are as follows :-
1,) The loss absorbing Power - The capital has a loss absorbing power in a way it can help to cover any losses when the liabilities for the bank becomes greater than assets or the banks make massive amount of losses.

2.) Confidence Impact- The capital in a bank serves an important function for developing confidence in the clients including depositors and creditors that their money is safe.

3) The financing impact - the capital in a bank serves as a good financing function in a way that it helps to provide financing to the stakeholders in the form of loans, bridge financing etc.

4) Serving other services- The capital in banks is also used for providing several other services including insurance, letter of credit, etc.


The different types of acceptable capital under Basel II are as follows :-


1.) Tier 1 - Common Stock + Reserves + retained earnings + deferred tax assets
2.) Tier 2- Tier 1 + bank reserves + subordinated instruments with no specific maturity etc.
3.) Tier 3- Tier 2 + subordinated loans of short term.


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