Reserve capital is one of the capital existing in companies (we can find them in company like joint-stock company or limited liability company. This is a part of own capital which is created by:
- Specific reserves
- In case of individual collect resources by owner of companies (so- called discretionary reserves)
- In a moment when composition of the balance sheet is changing and value of them
- When the sales profit is higher than them normal value
Reserve capital is really important because this may be using in the crisis moment of company. In this kind of situation the owners very often have to use foreign capital for example bank credit or loan. This capital could be also using in a lot of different way. For example, use them to spend on development of company. All decisions related with the use of this capital are made on meeting of shareholders. As bigger is the reserve capital than risk of undesirable effects is lower.
Reserve capital is very often mistaken for supplementary capital but in practice this is other kind of capital. In supplementary capital transferred is nothing less than 8 percent of profit which has been achieved for whole financial year. The exception is situation when this capital is equal or bigger than 1/3 of whole company capital. General assembly of shareloaders make decision how to use both reserve and supplementary capital. Although what is very important, cash from reserve capital which is approximately 1/3 of company capital, can be used only for cover loss which was show in financial report of this company. In situation where management prepare balance sheet which shows loss bigger than summary of company capital and supplementary capital and 1/3 of whole capital of company, the management is obligated to convene of general meeting of shareloaders to decide about existence this company in future. So, in practice the supplementary capital is using to cover losses in company, and reserve capital is destined to mostly on development of company. The common feature capitals presented above is fact that both is mandatory in limited liability company.
Reserve capital in banking
In the bank area the reserve capital shall be considered as capital buffer. All kind of financial institution like for example bank are obliged to preserve financial impact. For this reason they must have sufficient financial resources to cover financial losses and stay afloat in the event of crisis or something other situation which revenues are lower than needed. In the case when ones of bank is insolvent, this could be flounce of all of financial system. In this situation we are make sure that close this bank will not cause a “chain reaction”.
All banks are obligated to have minimum two kinds of financial buffer: the countercyclical capital buffer and capital conservation buffer. This meaning that this banks are obligated to have enough big own capital which can redeem losses in case of money problems. Apply buffers can reduce a financial requirements.
First buffer (countercyclical) is intended to reduce impact between economic cycle and the credit activity of this bank. In the periods of good prosperity banks have to collects the greatest possible supply of capital to in periods of poor state can use them to protect lending activities. When bank doesn't have this buffer, must proceed as in the case lack off capital conservation buffer.
Second buffer (conservation) is obligated banks to have enough big capital stock to preserve whole banks capital of this bank. If some bank doesn't have this buffer is forced to stop or reduce payment of all bonuses and dividends.
Difference between reserve capital and capital reserve
At the end we must remember that reserve capital is not the same as capital reserves. The reserves of capital protect bank against negative proceed of economy processes. This reserves are long-term and may be invested at the option. They are part of own capital, collect by the owners and they are not mandatory in opposite of reserve capital.
- Eberlein E., Madan D. B. (2010). Unlimited Liabilities, Reserve Capital Requirements and the Taxpayer Put Option, "Unpublished Working Paper", p. 2-3
- Freixas X., Bruno M. Rochet P. J. (2000). Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank , "Journal of Money, Credit and Banking", p. 611-638
- Guidara A., Lai V. S., Soumare I., Tchana F. T. (2013). Banks’ capital buffer, risk and performance in the Canadian banking system: Impact of business cycles and regulatory changes, "Journal of Banking & Finance", p. 3373-3387
- Repullo R., Salas J. S. (2011). The Countercyclical Capital Buffer of Basel III: A Critical Assessment, CEPR Discussion Paper No. DP8304, p. 32
- Stolz S., Wedow M. (2011). Banks’ regulatory capital buffer and the business cycle: Evidence for Germany, "Journal of Financial Stability", p. 98-110
- Eberlein E., Madan D. B. (2010)
- Freixas X., Bruno M. Rochet P. J. (2000)
- Repullo R., Salas J. S. (2011)
Author: Justyna Chłopek