Question

• Describe what is meant by bank capital and discuss how banks determine the optimal amount of capital to hold. Since a bank’s capital is generally less than 10% of its assets, discuss how this compares to the average capital structure of manufacturing corporations and explain this difference.

Answer 1

Bank capital is the excess of the amount which the bank has to the amount which bank owes. It is stored in the bank in the form of cash or other assets which are kept to meet the obligations which might arise in due course.

The amount of bank capital is generally very less like 10% because it knows by its historical experience that all the people will not come to withdraw their money at the same time and since the working capital or service sectors is low, they can manage with low capital as well unlike the manufacturing sector. In manufacturing sector the working capital requirement is very high because a lot of amount is required for raw materials, giving credit facility, plant & machinery, wages, debtors etc.

So while the bank's capital is 10% of assets but in case of manufaturing the assets may be as high as 100% of the total capital.

The bank maintains its capital mainly from the deposits made the customers while the manufacturing concern gets its capital in the form of debt(debentures, loans) and equity(shareholders). The cost of capital of bank is lower as compared to manufacturing as bank accepts deposits at lower interest rates.