Thursday, October 22, 2009

Determining The Amount Of Available Capital

The available capital is the current value of the assets current value of the liabilities. If all the assets and liabilities are traded, their values are simply the price at which they are traded. If the assets include assets, which are not traded frequently, then the reasonable value for those assets can be assigned.

Reasonable Value of Assets = Nominal Value - (Specific & General provision)

Nominal Value is the total amount owed to the bank. The specific provisions is the amount that is expected to be unpaid by customers who are already in financial trouble. The general provisions is the amount that is expected to be unpaid by other customers, who get in trouble over the next years.

Capital = Nominal Assets Value – provisions – liabilities.

In short run the board of director can also increase the capital by issuing more share without creating any outside liabilities and in long run it increase capital through accumulation of retained earning by not paying dividends to share holders at required rate.

Allocating Risk Limits To Each Business Unit/ Segment With In The Bank: After determining the target debt rating and amount of available capital, the bank’s total risk capacity is fixed.

Risk Capacity = Probability of default X Available Capital

The bank can decide total risk capacity in different segment of its business like trading, credit cards and corporate lending. The bank must consider the expected return from each unit and the diversification of the risk between different segments. The risk capacity is allocated by giving each business unit a limit on the amount of risk it can take. This limit may be in terms of risk capital or in more familiar terms, such as the total amount of loans it can give.

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