Capital Base

Capital Base
See also

Capital base- it is a term that describes a company's capital structure used a way of assessing the company's worth. Used by individual investors publicly traded companies, and banks to refer to a base level of funding. In the financial sector, it refers to a specific amount.It is the basis for measuring profitability, which allows you to gather basic information about a given company[1].

The capital base is the foundation for the work of a banking institution. Equity or capital base is the number of funds that will be distributed among the shareholders of a banking institution in the event of bankruptcy of the enterprise (loss of license, closure). The presence of equity guarantees banking institution stability in the banking sector and complete independence. Equity or capital base is the number of funds that will be distributed among the shareholders of a banking institution in the event of bankruptcy of the enterprise (loss of license, closure)[2].

Capital base in the overall structure of the bank’s resources

Commercial banking institutions for the normal conduct of business need financial resources, that is, certain resources. Moreover, the bank's capital can be represented as a combination of finances that are at the disposal of the structure and are used to carry out certain banking transactions. According to the peculiarities of formation, the capital of a banking institution can be divided[3]:

  • own funds (capital base): money received from the shareholders of the company at the time of creation and in the process of doing business, available reserves and so on. A feature of such capital is the possibility of its use without any time limit. In turn, the share of equity (capital base) is about 20%. In the best case, this indicator can reach 30%.
  • attracted funds: customer money that is received in the form of deposits for a specific period of time or on-demand. In addition, borrowed capital obtained from credit enterprises can also be attributed to this category. As a rule, the total share of such funds is about 80% of all resources of the institution.

The main functions of the capital base

The capital base performs several important functions[4]:

  • Protective function. The presence of equity is a certain security buffer for a banking institution, which allows covering current losses (if any) before global decisions are made by the management of the banking institution. At the same time, the bank can continue its activities, not paying attention to current losses.Also, the presence of a powerful capital base allows the bank to make risky transactions to increase its capital. This is a big plus, because losses that occur in the process of unsuccessful transactions will always be covered by equity. In turn, customer money remains intact. If the bank loses its license, it will always be able to compensate for current debts to depositors or lenders.
  • Regulatory function. The capital base is a powerful regulator of the bank, through which certain standards of economic behavior are set. Thanks to this, the bank is reliably protected from increased risks. If you look at the current legislation, the basic economic norms are based on the volume of the capital base of a banking institution. The scale of the structure's activity depends on this factor. The more personal funds, the greater the volume of active operations a bank can perform.
  • Operational function. Own funds are the main source of the formation of material resources and the development of the capital base of a banking institution. For example, at first, the authorized capital performs the function of start-up funds, which are used to purchase the necessary equipment, rent or erect buildings, hire workers, and so on. Without such funds, the bank simply cannot begin its activities.As it develops, the company expects to receive additional capital, expand the range of its services, as well as introduce the latest banking technologies. In this case, the bank's funds also act as the main source.
  • Pricing function. The larger the capital base of the bank, the stronger the trust on the part of the client and the less the risk of cooperation with a financial institution. In turn, a banking institution, as a lender, will be able to satisfy all requests for consumer and commercial loans. In the case when a bank is organized in the form of a joint-stock company, the value of its shares largely depends on the amount of equity. And the most important thing. In the case of assessing the total value of a banking institution, the main parameter is always the number of net assets, that is, the capital base.

Footnotes

  1. Kashyap A., Stein J., (2004), p. 18
  2. Rakhi S., (2019)
  3. Franse de Weert, (2011), p.15
  4. Kahn M.Y., Jain P.K., (2005), p.1.10

References

Author: Andrii Poliman