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FINANCIAL INSTITUTION AND MARKETS ASSIGNMENT

DONE BY ASHWIN KAILASAM N(10UTA08)

Bank Arguments 1.The main arguments for increasing equity capital requirements is that it will provide banks and incentives to take less risk the recent behind this is equity share holders are the real owners and even the firm doesnt them excepted return on their investments is not necessary before them to pay the return to the equity holders 2.since there is a economic growth in the economy, and the banks should provide loans at the same pace but if it is short of the capital to lend the money to investors, other banking institutions will make use of this opportunity to get a good perception in the minds of the investors. So we need to raise the capital requirement inorder to meet the increasing growth of the economy. 3.some of the banking institutions restricts the amount of money deposited by depositors to certain limit. They use some other ways to increase the capital through increasing interest rate for money borrowed & increasing the commission for other banking services like DD charges. So that they have enough capital requirement to meet the needs of the economy. 4. As per the tier 1 requirement , each bank should have capital requirement which is 4% of weighted average calculation of the total asset value in a bank. So if a bank doesnt meet this tire 1 reqirement, they need capital to meet the required conditions.

Depositors: y Commercial banks want a high capital so they give high interest rates to depositors which encourage them to deposit more and increases the demand. So the depositors get the benefit of increased interest rate which would increase their profitability on their deposits. During the financial crisis, many of the firms made losses, so the investors made a huge loss due to this because of fall in market shares. But the depositors who have their money in banks is safe though they do not make any profits out of it. They had a safe place to store their money instead of making losses by investing. Location of commercial banks is spread all over the country. Thus making it easily available and accessible to the depositors. FDIC insurance benefit is only for the depositors.

y y

Share holders: There are several benefits given to the share holders. Some of them are listed below

The inflation rate is greater than commercial bank interest rate but rate of growth for the stockholders is far beyond individuals who deposit in bank. Here are some of the additional benefits to shareholders y The stockholders with increasing capital have the advantage of commercial banks issuing more commercial papers making the firm to make more profit through the firm than from the commercial bank deposits. This increases the profitability of the firm and thus benefiting the firm. The peoples who are supposed to invest in long term projects prefers long term debentures which earns them a regular income even though the company is not performing well. This profit is high for the stockholders compared to the depositors. If the capital increases in the commercial banks the banks peform well through loans to the investors increasing their assets. So their market share in trade market increases. So the shareholders already holding such bank stock gets capital appreciation and increase in their share prices compared to their previous transaction of buying it.

Society: y The banks market price movements depends also on corporate social responsibility(CSR) i.e how much of capital they spend for benefiting the society. So inorder to increase their market prices and shares they serve the society thus benefiting both themselves and the society. The capital in the reserve bank makes it to lend the money among the state governments which they utilize to build fixed assets like dams and roads which inturn give employment to large group of people benefiting with money and property too through construction of these social buildings.

Disadvantages: Stockholders: y High Risk: During the financial crisis 2008, due to subprime lending the company had a heavy loss on their investments because FDIC doesnt provide insurance during these periods. Lower in share prices because of poor performance of the company.

Depositors: y Interest rate earned from these commercial banks is very low thus making very low profits on their deposits.

The interest rate during the financial crisis crashed down to 1% during 2008. So they make very low profit on their deposits even though their money is safe in the banks.

Society: If the capital increases in commercial banks, the credit card owners of the bank have to pay a high interest rate compared to previous one when repaying for their purchases. This would make them to avoid using credit cards and would be motivated use cash or debit cards rather than credit cards. Additional funds needed when bank acts as broker: Rule 15c3-3 a broker or dealer must have $ 1,00,000 as their additional funds. But if they could not follow the rules mentioned they must maintain a fund of $ 25,00,000 when acting as a broker. Yes these new business of brokerage is insured by FDIC. Due to increase in the capital the banks are in a position to take risk of lending a large amount of money to the investors, so has a greater probability of making high profits. Even if the firms fail in their projects bank can recover their lendings through insurance being done on that investment. So they have faith in these business if any critical situation occurs they can recover the damages or losses that can occur during that time. In the past few business went to bankruptcy due to subprime lending that doesnt have any insurance on the money we invest on a property. So the depositors have a greater risk at that time. Examples In todays market place FDIC monitor all banks deposits, certain retirement accounts, savings account, joint accounts are insured banks like bank of America, Citibank, Compass bank are the examples of the insured institutions. Reference:
www.financialregulationforum.com/.../fed-considers-raising-capital www.people.hbs.edu/lwhite/.../crises%20and%20capital%20CURRENT.pdf www.riksbank.com/upload/Dokument_riksbank/Kat.../Tal/.../110201e.pdf www.users.ox.ac.uk/~bras0541/CapAdForthcoming.pdf