Managing Bank Capital: Capital Allocation and Performance Measurement, 2nd Edition

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Capital-Based Management Techniques

This chapter briefly reviews the various components of managing capital, and highlights the major issues which need to be addressed in each. After first asking why it is that capital is such an important part of managing a bank, I review the four different perspectives of capital, around which the next four sections of this book are structured.

WHY IS CAPITAL IMPORTANT?

Capital management—in the sense of funding the enterprise—is well-covered by most standard corporate finance textbooks, so why is it so special and important for banks? The answer lies in the nature of capital as defined earlier: the primary purpose of capital in a financial institution is to absorb financial risk, not to provide funding for the assets of the business. Since the absorption of financial risk is not just incidental to a bank's business, but forms an integral part of the business itself, it follows that capital is itself an integral part of the business.

The importance of capital is amply illustrated by the focus given to capital levels by the various interested parties. The banking supervisors (or regulators—the terms are used interchangeably throughout this book) have deemed capital so important that the single global standard for determining banking strength is based around capital. Credit ratings agencies also place considerable importance on the level of capital. And finally, no stock analyst's report is complete without an assessment of the extent to which ...