The first term we need to understand is “capital.” “Capital” for a bank is somewhat different from the way we generally understand the word in our day-to-day lives. We understand capital as money. But in a banking sense, it means that and more.
“Capital” in banking generally refers to a part of a bank’s assets that doesn’t need to be repaid. In a few exceptional cases, it may include a part of a bank’s assets that needs to be repaid far ahead in future.
Many times “capital” is also referred to as “reserve.” This is because it’s the amount a bank would have available in case things go wrong and it’s unable to make money from its routine operations (see image above).
Bank capital has three primary features:
- Bank capital does not need to be repaid
- No dividends or interest payments are due on bank capital
- The claim priority on bank capital in case of bankruptcy is low
Capital at all banks like JPMorgan (JPM), Goldman Sachs (GS), Morgan Stanley (MS), Wells Fargo (WFC), and other banks in an ETF like the Financial Select Sector SPDR Fund (XLF) have the same features.
In the next part of this series, we’ll look at the different types of capital a bank has. Keep reading to know more.