Problems and Solutions on Capital Adequacy ratio

Problem 1
Using the figures below:
Perpetual preferred stock $ 1,644,000,000 Minority interest in subsidiaries $ 3,075
Common stock 31,428,000,000 Subordinated notes and debentures 20,998
Surplus 71,412 Intangible assets 5,070
Undivided profit and reserve 44,060 Limited life preferred stock 102
Foreign currency translation adjustments (298) Allowance for loan losses 54,077
Mandatory convertible debenture 3,001 Total assets (book value) 3,355,666
Total liabilities 3,120,501
Equity notes 815
Calculate:
a. GAAP; b. RAP; c. Primary capital; d. Secondary capital. core capital (Tier 1), and
Supplementary capital (Tier 2).
Solution
a. GAAP capital = Asset’s book value – liabilities’ book value
= 3,355,666 – 3,120,501 = 235,165 million
b. RAP capital = Stockholders’ equity + Preferred stock + Loss reserves +
Subordinated debentures + Miscellaneous items
= (31,428 + 71,412 + 44,060) + 1,644 + 54,077 + 20,998 + (3,075 + 815)
= 227,509 million
c. Primary capital = Common stock + Perpetual preferred stock + Surplus + Undivided
profits and reserves + Mandatory convertible debt + Loss reserves +
Minority interest in subsidiaries – Equity commitment notes –
Intangible assets
= 31,428 + 1,644 + 71,412 + 44,060 + 3,001 + 54,077 + 3,075 – 815 –
5,070 = 202,812 million
d. Secondary capital = Limited life preferred stock + Subordinated debentures
= 102 + 20,998
= 21,100 million
e. Core or Tier one capital = Common stock + Surplus + Retained earnings + Perpetual
preferred stock + Minority interest in subsidiaries – Goodwill
= 31,428 + 71,412 + 44,060 + 1,644 + 3,075 – 5,070 = 146,549 million
f. Supplementary or Tier 2 capital = Allowance for loan and lease losses + Debt capital +
Equity notes + Limited life preferred stock
= 54,077 + 23,999 + 815 + 102 = 78,993 million

Problem 2
Consider the following balance sheet information on Willow River National Bank:
On balance sheet items include:
Cash $ 120 million
Domestic inter-bank deposits 240 million
U.S. government securities 450 million
Residential real estate loans 370 million
Commercial loans 520 million
Total assets $ 1,700 million

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 Total liabilities $ 1,569 million
Total capital $ 136 million
Off balance sheet items include:
Standby credit letters $ 75 million
long term loan commitments to
private companies 180 million
a. Please calculate Willow River National Bank’s total risk weighed assets, based on the items
that the bank reported on its latest balance sheet, shown above. Does the bank appear to have
a capital deficiency?
b. Suppose that Willow River National Bank, whose balance sheet is above, reports the forms
of capital shown in the table below as of the date of its latest financial statement.
Common stock (par value) $ 18 million
Surplus 22 million
Undivided profits 84 million
Allowance for loan losses 75 million
Subordinated debt capital 40 million
Intermediate term preferred stock 12 million
What is the total dollar volume of the bank’s Tier I capital? Tier capital? According to the
data given, does Willow River National Bank have a capital deficiency?
Solution
a. Calculation of on-balance sheet items and credit equivalent off balance sheet items:
Assets items Risk weight
Cash $ 120 × 0 = 0
U.S. government securities $ 450 × 0 = 0
Domestic inter-bank deposits $ 240 × 0.20 = 40 million
Standby credit letters $ 75 × 0.20 = 15 million
Residential real estate loans $ 370 × 0.50 = 185 million
Commercial loans $ 520 × 1.00 = 520 million
Long term corporate credit commitments $ 90 × 1.00 = 90 million
Total risk weighted assets $ 850 million
Willow River’s overall capital to assets ratio is:
Total capital $ 136 million
Capital adequacy ratio = Total risk weighted assets = $850 miliion = 0.16 or 16%
Overall, it does not appear from the information given above that Willow River has a capital
deficiency.
b. Willow River National Bank has the following Tier I and Tier 2 capital items and totals:
Tier 1 capital = Common stock (par) + Surplus + Undivided profit = 18 + 22 + 84 = 124
million
Tier 2 capital = Allowance for loan loss + Subordinated debt capital + Intermediate term
preferred stock = 75 + 40 + 12 = 127 million
The bank appears to have enough Tier 1 capital to meet current regulatory requirements.
However, it has excessive Tier 2 capital which is not supposed to exceed 100 percent of Tier
1 capital.

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Problem 3
Using the information presented below for Premier Western National Bank, calculate that bank’s
required level of capital based on the new international capital standards. Does the bank have
sufficient capital under the new international capital standards?
On balance sheet items (assets) Off balance sheet items
Cash $ 2.5 million standby credit letters backing municipal bonds $ 18.1
U.S. Treasury securities 25.6 Long term binding commitments to corporate 40.2
customers
Deposit balances due from other banks 4.0 total of all off-balance sheet items $ 58.3 million
Loans secured by first lines on residential 8.7
property (1-4 family dwellings)
Loans to corporations 108.4
Total assets $ 149.2 million total capital $10.5 million
Solution
Calculation of risk weighted assets
Assets items Risk weight
Cash $ 2.5× 0 = 0
U.S. Treasury securities $ 25.6 × 0 = 0
Balances at domestic banks $ 4 × 0.20 = 0.80 million
Credit equivalent amounts of standby credits $ 18.1 × 0.20 = 3.62 million
Residential real estate loans $ 8.7 × 0.50 = 4.35 million
Loans to corporations $ 108.4 × 1.00 = 108.4 million
Credit equivalents of long term commitments $ 20.1 × 1.00 = 20.1 million
Total risk weighted assets $ 137.27 million
Total capital $ 10.5 million
Capital adequacy ratio = Total risk weighted assets = $137.27 miliion = 0.0765 or 7.65%
The capital adequacy ratio is just below the minimum total capital (Tier one + Tier two)
requirement of 8 percent. Premier will probably need to raise additional capital.

Problem 4
Silsbee National Bank and Trust Company reported its capital position to examiners earlier this
month. The bank currently has $ 825 million in total assets, $ 779 million in total liabilities, and
$ 46 million in total capital, broken down in this table:
Components of total capital Dollar amount of each capital
component (millions)
common stock $ 3.1
Surplus on common 4.70
Perpetual preferred stock 0.80
Surplus on preferred 0.60
Limited life preferred stock 0.20
Retained earnings 26.3
Mandatorily convertible capital notes and debentures 5.9
Reserve for loan losses 4.4
$ 46.0 million
Silsbee’s current price on its common stock is $ 3.50 per share, with 10 million common equity
shares outstanding. It has 50,000 shares of preferred stock outstanding at $ 10 per share.
a. What is the market value of the bank’s capital?

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b. What size capital deficiency does the bank have, if any, according to the international capital
standards?
Solution
a. Market value of common stock = Price × Number of shares
= $ 3.50 × 10,000,000 = $ 35,000,000
Market value of preferred stock = Price × Number of shares
= $ 10 × 50,000 = $ 500,000
The total market value of the bank’s stock = $ 35,000,000 + $ 500,000 = $ 35,500,000
b. Tier 1 Capital = $ 3.1 + 4.7 + 26.3 + 0.8 + 0.6 = 35.5 million
Tier 2 Capital = 4.4 + 5.9 + 0.2 = 10.5
Tier 1 capital $ 35.5 million
Tier 1 capital ratio = Total assets = $825 miliion = 0.043 or 4.3%
Tier 2 capital $ 10.5 million
Tier 2 capital ratio = Total assets = $825 miliion = 0.0127 or 1.27%
Total capital $ 46 million
Total capital ratio = Total assets = $825 miliion = 0.0558 or 5.58%
The total capital to total assets ratio is well below the 8 percent level. The tier 1 capital ratio
is satisfactory; however, the tier 2 capital ratio is very low.