Assessing Capital Adequacy and Capital Actions: Putting it All Together

Lourenco Miranda

We introduce this chapter on capital adequacy assessment by pointing out that it is worthwhile to go back to basics occasionally and to think about the metric system used in the stress-testing exercise under the CCAR framework. In simplified terms, all of the things that a bank does when performing a comprehensive capital analysis and review bring it to the creation of a very important product: the balance-sheet projection.

A balance sheet is a statement of the financial position of a bank at a particular moment in time. It shows the two sides of a bank’s financial situation: what it owns and what it owes. The sum of what a bank owns (its assets) is always equal to the combined value of what the bank owes (its liabilities) plus the value of its shareholders’ or owner’s equity. Expressed as an equation, a bank’s balance sheet is: assets = liabilities + equity. This point of view is fundamentally different from the economic approach of the Basel capital accords.

Shareholder equity is simply what remains after the total liabilities that are owed to non-shareholders are subtracted from the total assets. It can be calculated by asking, “If we sold all the assets of the bank, and

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