Capital’s importance

Now that you have a good idea about what capital is and the types of capital, you must be wondering why capital is so important. We’ve stated earlier that capital is used to absorb shocks during a bank’s worst periods.

Capital is important because it’s that part of an asset which can be used to repay its depositors, customers, and other claimants in case the bank doesn’t have enough liquidity due to losses it suffered in its operations. Capital doesn’t include any claims by bank equity holders.

Must-know: Why capital in banking is important


Capital also helps the bank in times of a liquidity crisis. We talked about liquidity crises in our series on risks. Click here to learn more about liquidity crises and risks.

Look at the chart above. A large part of deposit in a bank is the floating deposit. Suppose that due to a reason such as a rumor or a poor economy, many of these depositors want their money back simultaneously. But a bank has already lent that money to those that are taking loans.

How does a bank pay back its depositors? It does so from the capital that the bank has. If the capital wasn’t there, then the bank would have no money to pay off its depositors and would have to declare bankruptcy. Once the situation becomes normal, the bank can resume its operations.

A strong capital base is an indicator of a bank’s strength to depositors and investors. A strong bank will attract more deposits. Also, its equity offering will fetch high subscriptions and high issue prices.

Banks like JP Morgan (JPM), Goldman Sachs (GS), Morgan Stanley (MS), Wells Fargo (WFC), and other banks in an ETF like the Financial Select Sector SPDR Fund (XLF) all hold good capital level to make themselves attractive to depositors and investors.

Latest articles

23 Apr

Why Fiat Chrysler Stock Tanked 5% on Tuesday

WRITTEN BY John Parker

In April so far, Italian-American auto giant Fiat Chrysler Automobiles (FCAU) has outperformed the broader market by a wide margin after underperforming in the first quarter.

Royal Dutch Shell (RDS.A) is slated to release its Q1 2019 results on May 2. Before we review the Q1 2019 estimates, let’s recap Shell’s Q4 2018 performance compared to forecasts.

United Parcel Service (UPS) is scheduled to report its first-quarter earnings results on April 25.

Cleveland-Cliffs (CLF) is expected to report its first-quarter earnings results on April 25.

While the overall cannabis sector experienced weakness on April 23, some stocks managed to gain some positive momentum in the first half of the day.

After being listed on the NASDAQ (QQQ) on March 29, Lyft (LYFT) stock has traded on a negative note so far.