How do you improve capital ratio?


Quick Answer

A bank can issue new stock or sell subordinated debt to increase capital ratio if the bank is publicly traded, according to William F. Hummel, chief scientist of Control Systems Laboratory. Alternatively, a bank can improve its capital ratio by reducing its assets, although this option can potentially affect the bank's profitability.

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Full Answer

Hummel explains that a bank's capital is equivalent to its assets minus its liabilities. In the event that the assets are liquidated and liabilities are paid off, the capital is the margin by which the bank's creditors would be covered. A bank's capital ratio measures its financial health. In 1989, the United States adopted the capital requirements set by the Bank for International Settlements in Switzerland. The BIS capital ratio requirements designates the minimum capital as a percentage of the bank's risk-weighted assets. The BIS requirements are divided into two capital categories: the Tier 1 capital and total capital. The sum of Tier 1 and Tier 2 capital is the total capital.

Issuing new stock or selling subordinated debt can be costly if a bank is in a weak position, notes Hummel. Small banks often cannot sell new stock, as most are not publicly traded. An alternative option to improve capital ratio is to merge with a stronger bank.

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