Bank Capital Adequacy, Deposit Insurance and Security Values

Abstract

Since the first owner of a gold depository discovered that profits could be made by lending some of the gold deposited for safekeeping, there has been a concern for the “capital adequacy” of depository institutions. The idea is simple enough. If the value of an institution's assets may decline in the future, its deposits will generally be safer, the larger the current value of assets in relation to the value of deposits. Defining capital as the difference between assets and deposits, the larger the ratio of capital to assets (or the ratio of capital to deposits) the safer the deposits. At some level capital will be “adequate,” i. e., the deposits will be “safe enough.”