Wize University Macroeconomics Textbook > The Monetary System
Bank Capital and Leverage Ratio
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Bank Capital and Leverage Ratio
- Bank capital - the resources a bank's owners have put into the institution
Example:
Assets Liabilities
Reserves $200 Deposits $800
Loans $700 Debt $150
Securities $100 Capital (owners' equity) $50
- Leverage - the use of borrowed money to supplement existing funds for purposes of investment
- Leverage ratio - the ratio of assets to bank capital
In the above example the leverage ratio =
1000/50 = 20
- A leverage ratio of 20 means that for every dollar of capital that the bank owners have contributed, the bank has $20 of assets. This means of the $20 of assets, $19 are financed with borrowed money - either by taking in deposits or issuing debt.
- In the example above, if the assets increase by 5% from $1000 to $1050, then the bank capital (owner's equity) would increase by5% * 20 = 100%from $50 to$100.
- This shows that small percentage changes in assets can lead to big percentage changes in bank capital (owner's equity), which can be risky.
- Capital Requirement - a government regulation specifying a minimum amount of bank capital