Bank’s Commitment to Capital Ratio Key to Survival

=====================================================

A key indicator that measures a bank’s commitment to maintaining sufficient capital reserves has been found to be crucial in determining the institution’s ability to stay afloat.

What is the Cooke Ratio?

The Cooke ratio, established by the Basel Committee in 1988, requires banks with an international presence to maintain a minimum standard of capital based on credit risks incurred. The ratio is calculated as the sum of a bank’s Tier 1 and Tier 2 capital divided by its risk-weighted assets.

Consequences of Non-Compliance

Banks that fail to meet this commitment can face significant consequences, including:

Insolvency
Bankruptcy if they are unable to generate sufficient cash flow from their loan portfolio to honor their commitments

Benefits of Compliance

However, banks that prioritize maintaining adequate capital reserves can benefit from increased profitability. According to a new study published in the Journal of Smart Economic Growth, compliance with prudential standards has a positive impact on the solvency of commercial banks.

Study Findings

The study analyzed data from 10 Tunisian commercial banks over a nine-year period and found that:

Banks that maintained higher capital reserves were more likely to remain solvent and profitable
Compliance with prudential standards is essential for maintaining a bank’s solvency

New Basel II Ratio

Under the new Basel II ratio, which comes into effect at the end of this year, banks will be required to maintain even higher levels of capital to ensure their solvency. The revised ratio takes into account not only credit risks but also operational risks, such as:

Inadequate internal procedures
External events

New Basel III Framework

In response to the global financial crisis, the Basel Committee agreed in 2009 on a modified regulatory framework known as Basel III. The new framework aims to strengthen regulation of trading book exposures and requires banks to maintain higher levels of capital and liquidity.

Capital Requirements Directive IV (CRD IV)

The CRD IV includes four key measures:

Increase in capital requirements
Introduction of a countercyclical capital buffer
Introduction of a leverage ratio
Introduction of two liquidity ratios

Conclusion

In conclusion, maintaining adequate capital reserves is crucial for banks to stay afloat and maintain profitability. Compliance with prudential standards is essential for ensuring solvency, and banks must prioritize building robust risk management systems and maintaining adequate capital reserves to ensure their long-term survival.