engleski

The Impact of Equity in the Assessment of Bank's Financial Soundness

The paper discusses costs and benefits of funding bank's business activities primarily with deposits or with an additional contribution of equity. Recent financial crisis has shown that increased uncertainty can make deposits excessively fragile and one of the main lessons learned from the financial turmoil was that a level of capital of the banks was not sufficient to cover losses arising from the problematic loan portfolios. Setting the level of the required capital is one of the top financial issues today. Therefore, the reform of bank regulation and supervision, known as Basel III, was done with the intention of setting new capital standards. One of the reasons of requiring higher level of capital could be the fear of systematic risk appearance due to the fact that, opposite to other companies, it is extremely important for banks to have an immediate access to short-term liquidity and to be continuously prepared to meet all of its obligations. Increased capital requirements, in order to maintain the ratio above the prescribed minimum, are in close relation to the degree of use of the financial leverage. Moderate shareholders’ costs of higher capital requirements can result, through improvement of soundness of a banking system, with substantial social benefits. Finally, in the context of measuring its optimal level, the capital should be high enough to cover all the bank’s risks and, consequently, it should be high enough to prevent an appearance of a new financial crisis which could have serious impact on the economy in general. Regarding the Croatian banking system, capital adequacy ratio on overall bank level maintained well above the prescribed minimum so it can be concluded that the banks are well capitalized. However, on the individual level, it has been shown that some banks still need additional capital to maintain the minimum capital adequacy ratio. Generally speaking, the most effective way to control risks and avoid future crisis is reducing the dependence on borrowing thereby relying more on own funds.

Bank equity ; financial leverage ; capital adequacy ; financial soundness

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