The problem of capital adequacy

The repercussions of the downturn in the market became immediately evident on banks’ profitability, which has been steadily declining over the last three years. And an aspect of the problem is reflected in dividends and the additional difficulties banks face in their drive for core business growth. Another aspect, which they prefer to keep under wraps, is their capital adequacy – no one expects banks to admit that they are short of capital, as this is the basis of their existence. In 2002, the size and composition of equity capital that was tied up in overseeing purposes and the capital adequacy indicator were both influenced by banks’ limited ability to raise new capital and by fast credit expansion. According to central bank governor Nicholas Garganas’s report, the sum of overseeing equity capital on a non-consolidated basis fell 0.24 percent in 2002, while total basic equity capital (Tier 1) fell 15 percent. This decline is due to two factors: the fall in reserves due to a write-down of portfolio losses against net worth and the rise in the number of the retained own shares that are deducted from basic equity capital. As the Bank of Greece notes, despite its reduction, basic equity capital continues to form the basic source of commercial banks’ overseeing equity capital and is a measurement of its quality. By contrast, complementary equity capital (Tier II) rose 134 percent in 2002, due to the issuance of higher-risk bond loans, leading to a change in the composition of basic equity capital, which covered 81 percent of total overseeing capital in 2002, against 92 percent in 2001. Although there is room for a further increase in complementary capital, given that difficulties may continue in increasing share capital, this does not apply to all banks, some of which are already near the legal limit. The total capital adequacy indicator on a non-consolidated basis for all banks stood at 12.5 percent at the end of 2002, compared to 13.6 percent a year earlier and 15.5 percent at the end of 2000. The basic equity capital indicator stood at a satisfactory 10.6 percent. Even more characteristic of banks’ difficulties is the fact that banks whose capital adequacy indicator is smaller than 9 percent accounted for 9 percent of the the total assets of commercial banks at the end of 2002, compared to just 1.2 percent at the end of 2001. This means either that most banks are facing a capital adequacy problem or that the biggest banks are in a more difficult position.