Chapter 9


A well-managed bank needs no capital, whilst no amount of capital can save an ill-managed bank.

—Walter Bagehot1

The capital of a bank should be a reality, not a fiction; and it should be owned by those who have money to lend and not by borrowers.

—Hugh Maculloch, U.S. Comptroller of the Currency, 1863

It is difficult to proceed far in bank analysis without coming to grips with the impact of capital on both the creditworthiness of banks and on perceptions of their creditworthiness. The idea that bank capital is the ultimate measure of bank creditworthiness is widespread.2 Much obeisance is paid to the importance of banks maintaining robust levels of capital, while banks in turn tout their capital levels as a sign of financial soundness. Indicators such as the Basel capital adequacy ratio (CAR),3 which came to the fore after the advent of the first Basel Accord of 1988, have acquired an almost talismanic significance, which seems to have only increased in the wake of the controversies that preceded the adoption of the second iteration of the Basel Accord (Basel II) in 2005. The aftermath of the credit crisis of 2007–2012, where governments rushed to recapitalize banks at taxpayer expense, has contributed to the ubiquitous perception that capital is by far a bank’s most vital financial attribute.

The belief that capital strength is the preeminent mark of a highly creditworthy bank is no recent phenomenon, as the quotations from Walter Bagehot and Hugh Maculloch ...

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