Question

Two competing commercial banks situated in the same region have comparable asset portfolios, but one operates with a total capital ratio of 10%, while the other operates with a ratio of 12%. Compare the opportunities and risk profiles of the two banks.

Answer 1

Ans: Capital Ratio

Capital Ratio is nothing but Capital Adequacy Ratio also known as capital to Risk-weighted asset ratio. This ratio measures the Banks capital with respect to its risk-weighted assets. Under the Basel III norms, Banks are required to maintain a minimum amount of capital ratio for the stabilities of the Banks. Under the Basel III norms, the minimum Capital Adequacy Ratio is 8%. The capital Ratio helps the banks in maintaining financial stability and helpful in better efficiency of the economic system throughout the world.

In this question, there are two commercial Banks situated in the same region but one operates with a 10% of Total capital Ratio and another operates with a 12% of Total capital ratio.

Generally, the Banks which has higher capital ratio are considered safer as compared to the banks which have a low capital ratio because the banks which have higher capital means it has maintained it's capital high enough to meet the financial crisis. Therefore the opportunity for the bank which is operating at 12% is that it can be able to manage its financial crisis better than the Bank which is operating at 10% But due to its higher capital ratio it may not be able to use its capital adequately and may end up in losing the lucrative profitable investment.

On the other hand, the bank which is operating at 10% capital ratio is riskier than the bank which has a 12% capital ratio. Therefore it may not be able to handle its financial problem as effectively to the other banks which have higher capital ratios and may end up in massive losses. But the opportunity for this bank is since it has a lower capital ratio, therefore, it may be able to use its capital to invest in lucrative portfolios to gain maximum returns.