The concept, structure and management of the bank’s own capital

 

Commercial banks, like other subjects of economic relations, to ensure its commercial and business must have a certain amount of money, i.e., resources. Under modern conditions of economic development problem of the formation of resources is of paramount importance. This is because the transition to a market economy model, the elimination of state monopoly on banking, building a two-tier banking system the nature of bank resources is undergoing significant changes. This is because, firstly, greatly narrowed nationwide fund banking resources and the scope of its operations concentrated in the first link of the banking system the Central Bank. Secondly, the formation of companies and organizations with various forms of ownership means the emergence of the new owners of temporary free funds, independently determining the location and method of storing money, creating a market of credit resources, organically included into the system of monetary relations.

In addition, the scope of activities of banks, defined by the object of its active operations, depends on the totality of resources available to them, especially the amount of borrowed resources. This situation aggravates the competition between banks to attract resources.

Simultaneously with the market credit starts functioning securities market, where banks are the sellers or buyers of their own government and corporate securities. Availability of insurance, financial and other lending institutions will intensify competition in the market of credit resources and exacerbates the accumulation of banks temporarily idle cash.

Resources of commercial banks or bank resources represent a set of own and borrowed funds at his disposal and used to carry out active operations.

By way of education, all commercial banks’ resources are divided into equity and debt (borrowed).

The main source of commercial banks’ resources is borrowed funds, constituting about 70-80% of total bank resources. The share of own funds of banks to between 22 and 30%, which is broadly in line with the existing structure of the global banking practice. As part of its own funds the bulk of the bank accounts for different funds. The second part of its own funds- profits this year.

The structure of the banking resources of individual commercial banks is very varied, because of its individual features.

The banks’ own capital, which consists for the banker (or banking house) of the means which belong to him and which, for joint-stock banks, consists of the receipts from the floating of bank shares. Banking capital brings its holder banking profit, the profit norm of which is equal to average profit in the economy as a whole, just as is the case with industrial and commercial profit. Thus, banking capital is functioning entrepreneurial capital, as distinguished from loan capital-capital as property. Under premonopolistic capitalism, banking capital kept itself apart from industrial capital and serviced the latter through short-term credit and accounting transactions. In the era of imperialism, monopolistic banking capital is intertwined with monopolistic industrial capital; as a result, financial capital is formed.

Under the bank’s own funds should understand the various funds set up by the bank to ensure its financial stability, trade and economic activities as well as profits as a result of the current and previous years.

The structure of the bank’s equity base is heterogeneous in composition and quality varies throughout the year depending on several factors and in particular on the quality of the assets of its own profits, the bank’s policy to ensure the sustainability of its capital base.

Statutory fund creates the economic basis of existence and is a prerequisite for formation of the bank as a legal entity. Its value is governed by legislative acts of the central banks and, moreover, is subject to agreement of the European Economic Community (EEC), which in 1989 regulated its minimum value of $ 5 million ECU.

Regulation of the Republic of Kazakhstan on Regulation and Supervision of Financial Market and Financial Organizations of September 2, 2008 № 140.Registered with the Ministry of Justice of the Republic of Kazakhstan, October 13, 2008 № 5339. Lost by the Board of the National Bank of Kazakhstan on December 24, 2012 № 383.

In order to ensure the financial stability of banks and protect the interests of their depositors Management Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Market and Financial Organizations has decided:

The minimum capital: for newly established banks, including the Agency received permission to open a bank, in the amount of 5,000,000,000 (five billion KZT).

The minimum capital for banks with no branches: for banks in the amount of 1,000,000,000 (one billion KZT);

For banks located outside the cities of Astana and Almaty, housing savings banks in the amount of 500,000,000 (five hundred million) KZT;

For existing banks, equity of each of them on October 1, 2009 is less than 10,000,000,000 (ten billion KZT) in the amount of 2,000,000,000 (two billion KZT), provided: re-registration of the bank outside the cities of Astana and Almaty; presence of deposits accepted from individuals and legal entities registered outside the cities of Astana and Almaty, except for deposits of special purpose subsidiaries of the bank and interbank deposits, in an amount not less than 50% (fifty percent) of the bank's liabilities./3/

Equity funds commercial banks play an important role:

- For the bank, since the volume and nature of ongoing both active and passive operations directly related to the amount of capital, which ultimately has a significant influence on the formation of performance;

- For the bank's creditors, as well as customers are on cash and settlement services, which is associated with ensuring the safety of their investments and guarantee the stability of service;

- For government agencies, including the Central Bank, who are interested in the stability of the overall economy, in particular, the banking system and the non-cash payments, as this stability can be achieved only if the commercial banks' own funds, inadequate, adequate market situation in its quantitative and qualitative parameters.

Thus, before the bank's management is a recurring problem replenish their funds.

Replenishment of bank capital in two ways:

- Increase of capital from domestic sources;

- Increase of capital from external sources.

The first method is to perform a specific dividend policy, the essence of which is to increase the share of profit retention by reducing (or relative reduction at constant profit growth) the payment of dividends to holders of common shares.

The second method consists primarily of additional issue of equity securities with the right to exchange for shares. By this method also includes sale of fixed assets, primarily real estate leaseback. This kind of transactions are most attractive in periods when inflation and economic growth well ahead of the current increase in value compared to its original value, as reflected in the balance sheet of the bank.

For the calculation of the equity capital of the bank can be used different methodologies. In most developed countries used the methodology proposed by the Basel Committee on Banking Supervision at the Bank for International Settlements. This technique is being implemented gradually and in banking in Kazakhstan.

According to this methodology, adjusted for specific features, in the sources of their own funds, in the calculation of basic equity, include:

- The authorized capital of the credit institution, organized as a joint stock company formed as a result of the issue and placement of ordinary and preference shares (other than cumulative, which cannot be paid dividends);

- Share premium for its shares at a price above their face value;

- Property, donated the property received by the bank from legal entities and individuals;

- Funds of the bank, formed from the profits of previous years and the current year, as well as retained earnings of the current financial year, confirmed by an audit firm;

- Provisions made by the bank for impairment of investments in shares of subsidiaries and affiliated companies.

Reduce the amount of sources of capital intangible assets, own shares purchased by the bank from shareholders; uncovered losses and losses of the current accounting year.

Reserve capital (fund) is created from net profit (after tax) in an amount not less than 15% of the paid amount of the share capital and is designed to absorb unexpected losses in the bank’s activities and ensure the stability of its functioning.

The second group of funds formed as a result of the distribution of net profits, remaining at the disposal of the bank (funds for special purposes), and also reflects the use of net profit for certain purposes.

The third group of funds, the combined name of “additional capital, consists of:

- Proceeds from the sale of shares of the first holder at a price above face value - “seignior age.” These funds increase the initial capital of the bank and its stable part;

- Capital gains, formed by the revaluation of fixed assets. The presence and magnitude of this fund is a reflection of inflation in the country and, therefore, do not act the qualitative characteristic of its activities. In its economic essence and nature of use of this fund can be regarded as a provision for impairment of fixed assets (fixed assets);

- The value of donated property received. The volume of the fund shows a source of growth of tangible assets of the bank, and the rules of use (to cover possible losses) can take it to a group of reserve funds.

The fourth group of funds established to cover the risks of certain banking operations and thus achieve the stability of banks by absorbing the losses due to the accumulated reserves. These include: provisions for losses on loans, securities and other assets. The value of these reserves suggests, on the one hand, the qualitative structure of bank assets, and on the other on the margin of safety of the bank, especially with regard to reserve funds created from net profit (for example, reserves for possible losses on loans first group).

The funds the second, part the third and fourth groups according to their intended purpose are very mobile, as they are used for current expenses or capital investment bank associated with the development of its own facilities (ego, payment of premiums, benefits, equipment, costs, ongoing in excess of the limits, classification of them on the operating costs, the provision of charity care, etc.), i.e. the use of these funds due to the decrease of the bank property.

Therefore, the funds of such funds or their equivalent cannot be left in the bank and use them for other purposes, i.e. act as a bank’s capital.

Thus, the theory of banking distinguishes the concept of equity and equity of the bank. The concept of “own funds” the most common include all liabilities, formed during the bank’s activities: the charter, reserve and other funds of the bank, all the reserves by the bank, and retained earnings from previous years and current year. Bank’s own capital a value determined by calculation. It includes the articles of their own funds (and even borrowed funds), which on the economic meaning can serve as the bank’s capital. The main elements of its own funds, i.e. underlying funds established in accordance with the law, and reserves established by domestic sources in order to maintain the bank’s activities are included in the bank’s capital if they meet the following principles:

- Stability;

- Subordination to the rights of creditors;

- The absence of fixed charges of income.

Under the bank’s own capital should be understood specially created funds and reserves that are intended to ensure its economic stability, absorption and possible losses are to use the bank for the entire period of its operation. The bank’s capital includes statutory, reserve capital, other funds that do not have the period of use, promoter’s profit (the result of the emission), undistributed profits of the current and previous years, left at the disposal of the bank and confirmed by the auditors, the reserves to cover various risks and performs a number of important functions in the activity Bank.

Functions performed by the bank capital, ambiguously defined as a domestic and Western literature. There are three main functions: protective, operational and regulatory. Since a large proportion of bank assets financed by investors, the main function of a very limited amount of equity capital is protecting the interests of depositors. In addition, the capital of the bank reduces the risk of the bank’s shareholders. Protective function means that you can compensate depositors in the event of liquidation of the bank, as well as the preservation of solvency by creating a pool of assets, allowing the bank to work despite the threat of damages. In this case, however, it is assumed that most of the loss is covered by the expense of capital and current income of the bank. Unlike most companies preserve the solvency of the commercial bank to cover only part of equity. Typically, the bank is solvent, remains intact equity, i.e. while the value of assets is not less total liabilities (net of unsecured) issued by the bank and its shareholders’ equity.

Capital plays the role of a protective “cushion” and allows the bank to continue operations in case of large unexpected losses or expenses. To finance these expenditures, there are various reserve funds are included in shareholders’ equity, and for mass non-payment customers on loans to cover losses; you may want to use a portion of equity.

Operational function of bank capital is of secondary importance compared to the defensive. It includes the allocation of own funds to purchase land, buildings, equipment, and the establishment of a financial reserve for unexpected losses. This source of funding is indispensable in the initial stages of the bank, when the founders engaged in a number of priority spending. At subsequent stages of development bank role of equity capital is not less important part of the funds invested in long-term assets, the establishment of various reserves. Although the main source of financing for the expansion of operations is the accumulated profit, the banks often resort to new issues of shares or a long-term loan for events of a structural nature the opening of branches, merges.

Implementation of the regulatory function of capital is linked to the special public interest in the successful functioning of banks. According Picture 1, with the index the bank’s capital by public authorities assesses and monitors the activities of banks.

Typically, rules relating to equity of the bank include requirements to its minimum size restrictions on assets and conditions of purchase of assets of another bank. Prudential standards set by the central bank, mainly based on the size of the bank’s own capital. In terms of the classification of the functions attributed to the regulatory function and use the capital to curb lending and investment operations (to the extent that bank loans and investments are limited to available equity).

 

Figure 1. Bank Capital adequacy

 

Other sources, recognizing that the primary purpose of bank capital is to reduce risk, emphasize the following features:

- Capital serves as a buffer to absorb losses and preserve solvency;

- Provides access to capital markets, financial resources and protect banks from liquidity problems;

- Inhibits the growth of capital and reduces risks.

All these features help to reduce capital risk. Such an approach is more practical and suited for management purposes, a commercial bank.

The role of capital as a buffer against loan losses evident when considered in the context of cash flow. If bank customers fail to fulfill their obligations under the loan, instantly reduced cash flow from interest and principal payments. Outflow does not change. Bank remains solvent, while the amount of inflow exceeds the outflow. Here, capital serves as a buffer, because it reduces the induced outflows.

The Bank may postpone the dividend but shares not being able to pay. Interest payments on bank debt, by contrast, are mandatory. Banks with sufficient capital release new bonds or shares to replace the lost cash inflows of new and buy time until they solved the problem with the assets. Thus, the higher bank capital, the more assets may be unpaid, before the bank becomes insolvent, and the less the risk of the bank.

Adequate bank capital reduces the operational problems by providing free access to financial markets. Capital gives the bank to make loans from traditional sources at normal rates. Large shareholders ‘equity provides a stable reputation of the bank depositors’ confidence in him.

Capital inhibits growth and reduces the risk of restriction of new assets that the bank can purchase through financing with debt. This function is closely related to the norm established by the state authorities of capital to assets. So, if banks decide to increase the size of loans or buy other assets, they should support growth through additional equity financing. This prevents speculative asset growth, as banks must always remain within its capacity a successful asset management.

These functions of bank capital show that equity the basis of commercial bank activities. It ensures its independence and its financial sustainability as a source to offset the negative impact of various risks, which are borne by the bank.

Management of the bank resources is a complex process of their formation and placement, which is faced with certain restrictions in the form of prudential standards developed by international supervisory authorities and national, to which the acts regulating the activities of commercial banks provided a certain level of equity.

Equity capital for a commercial bank, as for any other commercial structure is the core activities that define its scope and volume of resource mobilization. In other words, the activity of commercial banks is largely determined by the size and structure of the equity.

Thus, in accordance with the Basel Capital Accord 1 as the main criteria for capital adequacy ratio of commercial bank to provide protection against financial risk indicator is proposed, where the capital is related to the bank's assets, which are weighted to risk. However, the basis for calculating the value of assets was put only the credit risk and other risks that the bank faces in operations accounted for indirectly through credit risk. In the future, this agreement was included in capital and market risk represents the loss of the bank as on-balance sheet and off-balance sheet positions due to adverse changes in market prices. Included in the calculation of risk positions of the trading portfolio for interest rate risk and equity instruments, the investment portfolio of the bank, etc. Changes in the practice of the banking business, manifested, in particular, changes in the structure and nature of banking risks, prompted the need for a new Capital Accord, known as Basel 2.

The main purpose of the adopted new Capital Accord is to provide greater sensitivity oversight mechanisms to risks assumed by banks and increase their composition to be included in the calculation of weighing the risk-adjusted assets.

Resource management of domestic commercial banks in terms of equity is also facing constraints in the form prescribed by the National Bank in accordance with the Basel prudential regulations that have a direct impact on the level of resources, the ability of banks to carry out high-quality storage and placing them with all the necessary requirements of the environment. /2, p.142/

One of the main features is the constraints of banking capital requirements, which require banks to comply with the required level of its components. It's Tier 1 capital adequacy of allocated resources in the assets and the bank's ability to cover its own capital resource investment in risky assets. These figures make it possible to limit the risk of banks at the stage of resource allocation. The emergence of risk is seen as a result of active operations and, therefore, greater attention on the part of the supervisory authority is given to risky assets. That, in accordance with the rules on prudential standards for banks adopted the decision of the National Bank of 3.06.02, the number 213 is made for the calculation of assets, commitments and contingent liabilities, which are weighted according to the standard risk set these rules. However, this method only allows you to subsequently assess the risk of investing the bank, but it does not take into account the possibility of the risk of demand means that in the first place will affect the risks for active operations.

Therefore, it should be noted that, along with the risks of active operations, which are accounted for and the Basel Accord and the National Bank, in determining the capital adequacy of the bank, there are risks of passive operations that are appropriate to take into account, calculating the ratio of equity to total deposits. Since the bank's equity capital and its protective function define it as a measure of protection of depositors' funds, it is necessary to define a measure of the adequacy of equity capital to meet their own obligations.

The coefficients which linked to bank’s own capital in Kazakhstan you can see in the picture 2.

The value of the capital adequacy ratio of the bank:

k1-1 is not less than 0.06;

k1-2 is not less than 0.06.

For a bank that does not have a large party - the individual, the value of the capital adequacy ratio of the bank:

k1-1 is not less than 0.07;

k1-2 is not less than 0.07.

For the bank, to which a bank holding company or parent bank, for the bank, more than fifty percent of the outstanding shares are owned by the state or the national management holding company, the value of the capital adequacy ratio of the bank:

k1-1 is not less than 0.05;

k1-2 is not less than 0.05.

The value of the capital adequacy ratio of the bank k2 is at least 0.12.

For a bank that does not have a large party - the individual, the value of the capital adequacy ratio of the bank k2 is at least 0.14.

 

Note - Compiled by the author according to the Instructions on normative values ​​and the method of calculation of prudential norms for second tier banks

 

Figure 2. Banks' capital adequacy ratios

 

In the USA, for example, one of the oldest indicators used to assess the adequacy of bank capital is the ratio of capital to total deposits, which should not be below 10%. It was used in the United States in the early 20th century by the Department of the controller in the analysis of monetary balances of national banks. In this regard, it is proposed to also determine the risk of attracted deposits from banks and for this use the following figure, which reflects cover potential risks in the formation of the bank's liabilities. /3/

Based on the fact that as a result of liability management of the bank to comply with the required level of liquidity, it is useful in determining the ratio of equity capital to total deposits take into account the sustainability of the deposit base of the bank.

There is a lot of regard for different methods of rating of validity of business banks in mass media recently. After interbank depression it has become more actual. The most available method of rating evaluation of reliability has become method by V. Kromonov. /4, p.75/(look at the Picture 3)

Really, this method permits sufficiently good to rate bank stability by using monthly and quarterly balance sheet.

Note - Compiled by the author according to the Kromonov’s method of evaluation criteria of reliability and stability of the banks

 

Figure 3 The system of coefficients by Kromonov

 

According to this method of evaluation criteria of reliability and stability of the banks are capital adequacy, asset quality, management quality, profitability and liquidity. Feature of the technique is the use of aggregate indicators in the evaluation of each criterion, as well as an assessment of the bank on a separate indicator. /6, p.432/ The set of these indicators are weighed according to the degree of importance among other indicators, a score is assigned, according to which there is a ranking criterion signs and overall ranking of the bank.