Which of the following is true?
options:
a. Bank capital = liabilities – assets
b. Bank capital = assets + liabilities
c. Bank capital = assets – liabilities
d. Bank capital = assets/liabilities
The correct answer and explanation is:
The correct answer is: c. Bank capital = assets – liabilities
Explanation:
Bank capital, also known as shareholders’ equity, represents the difference between a bank’s total assets and its total liabilities. It reflects the value that the bank’s owners (shareholders) have invested in the institution. The capital is essentially what would remain for the shareholders if the bank were to liquidate all of its assets and pay off all its liabilities.
Here’s a breakdown of the equation:
- Assets are everything the bank owns, such as cash, loans, and property.
- Liabilities are what the bank owes, such as deposits, loans from other banks, or bonds issued.
- Capital (Equity) represents the residual value, calculated by subtracting the bank’s total liabilities from its total assets.
This formula is similar to the basic accounting equation:
- Assets = Liabilities + Equity
Rearranging this equation gives: - Equity = Assets – Liabilities
In the case of banks, the capital is crucial for absorbing losses and ensuring the bank remains solvent. It acts as a buffer against financial downturns and protects depositors and creditors. Banks are required by regulators to maintain a certain level of capital relative to their assets to ensure they can absorb potential losses, maintain stability, and prevent systemic risks in the banking system.
Thus, the correct expression for bank capital is assets minus liabilities, reflecting the ownership value that the bank’s shareholders have in the institution.