Bank capital and liquidity - Bank of England.pdfVIP

Topical articles Bank capital and liquidity 201 Bank capital and liquidity By Marc Farag of the Bank’s Financial Stability Directorate, Damian Harland formerly of the PRA’s Banking Policy Department and Dan Nixon of the Bank’s Media and Publications Division.(1) • Bank capital, and a bank’s liquidity position, are concepts that are central to understanding what banks do, the risks they take and how best those risks should be mitigated. This article provides a primer on these concepts. • It can be misleading to think of capital as ‘held’ or ‘set aside’ by banks; capital is not an asset. Rather, it is a form of funding — one that can absorb losses that could otherwise threaten a bank’s solvency. Meanwhile, liquidity problems arise due to interactions between funding and the asset side of the balance sheet — when a bank does not hold sufficient cash (or assets that can easily be converted into cash) to repay depositors and other creditors. • It is the role of bank prudential regulation to ensure the safety and soundness of banks, for example by ensuring that they have sufficient capital and liquidity resources to avoid a disruption to the critical services that banks provide to the economy. Example of solvency problems Example of liquidity problems Assets Liabilities and capital Assets Liabilities and capital (‘Use of funds’) (‘Sources of funds’) (‘Use of funds’) (‘Sources of funds’) Cash