Question

Scenario: "The bank share price is relative to book value was below its competitor banks by about 25%. Management made it clear that is believed the share price was undervalued, as opposed to low - value due to the lack of investor confidence."

Question: How does the above affects a bank's capital adequacy and what can be done to address the issue?

Answer 1

Answer:

Capital Adequacy Ratio- CAR is the ratio that tells the relationship between bank's capital and risk weighted assets and current liabilities. CAR measures the of Bank's available capital as the percentage of its risk weighted credit exposure.

CAR protects depositors and increases the stability and efficiency of financial system.

This ratio is decided by central bank and banking regulation to prevent commercial bank from excess leverage and insolvency.

Formula:

CAR = (Tie 1 capital + Tier 2 capital) / Risk weighted average

There are factors that affect share price of bank. Share price may be undervalued due to lack of confidence of the investors. There is less demand of share of the company is the market that is the reason it is undervalued. Investors have lack of confidence to buy a particular company's shares based on fundamental and technical analysis. Bank's fundamentals may not be good or share is not looking technically strong that's why people are not buying the same.

When company's share price is undervalued, it will affect the company's market capitalization and capital. Lower capital will result lower CAR. Lower CAR shows that bank is not able to pay its debts and not able to bear the losses.