Importance of Capital to Banks

Importance of Capital to Banks

Importance of Capital to Banks

  • Type of paperOther
  • SubjectFinance
  • Number of pages1
  • Writer qualityStandard
  • Format of citationAPA
  • Number of cited resources3

Why is capital important to banks?


Importance of Capital to Banks

Banks assume an important role in the economy. But unlike other business undertakings, they are along these lines subject to broad scrutiny, including capital prerequisites as a vital component. Capital necessities identify with the size and structure of the risk capital. The capital prerequisites for banks depend on global gauges set around the Basel Committee (Simons & Opiela, 2010). This paper clarifies the unique role played by capital in banks, including its noteworthiness to the banks as credit lenders.

The most crucial role of capital is to guarantee the survival of the bank by giving a cushion against a deficiency in cash flow since profits can be suspended without cataclysmic outcomes. The banks are liable to an uncommon least capital prerequisite of 8% of the risk-weighted assets, overseen by the government (Simons & Opiela, 2010). The banks’ capital that holds in an overabundance of the 8% plus their present income guarantees their freedom and survival if there should be an occurrence of unforeseen losses (Naceur, 2009). With a given level of likelihood, the abundance capital reserves ought to cover the unforeseen misfortunes.

Another significance of capital is to maintain a strategic distance from inordinate financing costs for other financing alternatives than deposits. On the off chance that a bank would need to pay a high rate of interest on credits from different banks, securities issued by the bank if the bank’s overabundance capital reserves are observed to be deficient. The big banks wish to keep their high appraisals and along these lines have significant market-decided overabundance capital reserves (Naceur, 2009).

Capital is vital since it is part of an advantage which can be utilized to reimburse its investors, clients, and different petitioners in the event that the bank doesn’t have enough liquidity because of losses it endured in its operations. Capital does exclude any cases of a claim by bank equity holders. Furthermore, a substantial capital base is a marker of a bank’s quality to investors and depositors (Van den Heuvel, 2012). A strong bank will draw in more reserves, and its equity offering will bring high memberships and high issue costs.

Finally, a bank’s notoriety will be at risk if the bank finds it hard to meet the government’s capital necessities, regarding expansive losses on an advance presentation. The rating board makes requests in regards to the banks’ overabundance capital reserve as a condition for a high ranking. Moreover, adequate surplus capital reserves empower the bank to go into vast exposures without raising new capital.


Naceur, S. B., (2009). The impact of capital requirements on banks’ cost of intermediation and performance: The case of Egypt. Journal of Economics and Business61(1), 70-89.

Simons, R. P., & Opiela, T. P. (2010). Bank size, bank capital, and the bank lending channel. Journal of Money, Credit and Banking, 121-141.

Van den Heuvel, S. J. (2012). Does bank capital matter for monetary transmission? Economic Policy Review8(1), 259-265.