The Financial Express

Raising and diffusing equity capital in banking companies

| Updated: August 07, 2020 22:54:22

Raising and diffusing equity capital in banking companies

Unlike non-financial companies, the banking companies hold a very low ratio of equity capital in their capital structure. Astonishingly, this attribute prevails in the entire banking industry across the globe. It is very natural that one of the main reasons is the dominance of deposit, the biggest source of banks' fund.  But this reason does not sufficiently explain the unusually poor place of equity capital in the publicly held banks home and abroad. Apart from this low proportion of common stock, shareholding pattern is also highly concentrated in most cases. The Basel accords have made it necessary for each bank to maintain a minimum percentage of capital adequacy ratio, one of the components of which is common stock. To comply with the provisions of the Banking Companies Act and the Basel guidelines, a bank is required to issue and hold common stock capital. Ongoing discussion aims to focus upon two issues-(i) Raising the existing level of common stock capital as much as possible (ii) Maximising ownership dispersion or minimising concentration.   

The annual reports of the banks reveal that the equity capital (as per cent of total assets) in our banking industry ranges individually from 0.65 per cent to 5 per cent. An overview of the statistics on some countries of the world is presented below: 

The equity capital to total assets in countries stated in the table ranges from 0.044 per cent to 6.77 per cent. Indian banks show the lowest ratio of equity capital. Our banks' position is close to global statistics. It may thus be deduced from this uniform picture that the bank owners are not generally willing to raise the level of equity capital beyond the Basel standards on capital adequacy requirements.

There is much controversy over use of equity, deposit or debt in bank's capital-mix. Bank owners oppose maximising the holding of share capital in addition to regulatory capital arguing that the cost of capital as a whole increases while they can get deposit cheaply and mobilise more fund from the issue of securities and taking debt (bonds, subordinated and perpetual debt etc). Different evidence is also available. IMF Working Paper (19/265), December 2019 suggests that more equity in the capital-mix leads to a fall in firms' costs of equity. The findings of the paper also show that a one percentage point increase in a bank's equity-to-assets ratio drives down its cost of equity by 18 basis points. Moreover, there is another argument that common stockholders' claims are residual and not pre-determined. Business community should seriously weigh the fundamental differences between private and public limited companies.

Bankers across the globe are also reluctant to diffusing shareholding. Banking system is the critical arena of the economy where most of the wealthy and mighty group of owners tries to keep the functioning of the bank within their grip to realise their desired goals. Fortunately, as regards dispersed ownership, the majority of our banks lie far ahead of international banks and we may proudly pronounce that the general public of our country enjoy much liberal opportunity to invest in banking business. This type of desirable corporate behaviour has been possible because of the liberal role of our Securities and Exchange Commission (SEC). SEC laid down rules specifying the percentage of share issue allocation for the general public (i.e. 40 to 50 per cent depending upon the pricing method).However, global picture is gloomy. The egalitarian logic totally ignored is that the ownership diffusion contributes to moderating economic inequality in the society. Truly speaking, disguised capitalism has been housed in corporate settings all over the world.

The importance of bank capital has increased since the global financial crisis during 2007-2009. Ironically, this has been motivated by the need for window dressing of the balance sheet to avert bankruptcy. The Basel committee argues that more capital should make banks better able to absorb losses with their own resources. In consonance with the tone of the Basel Committee, many bankers also maintain that bank capital is necessary as a buffer against risks. Retained earnings, general reserve and loss provisions are used to offset credit losses. But is it justifiable to make common stock erode with other components of Tier 1 capital? Who gain at whose costs ? Do we ever  go into the depth of such strange solution ?

Raising the volume of equity capital and maximum possible diffusion of shareholding are essential to maintain public interest and sustainable success of publicly traded banking companies. People strongly desire that modern banking corporations would not behave like the East India Company which was born to exploit and deprive the people. A good number of our banking firms are worth scoring high at least in case of diffused shareholding. But everywhere else the reality is far from expectation. Necessary amendments to the Banking Companies Act, the Securities and Exchange Commission's Acts & Rules, and the Companies Act are crucial everywhere in the world. Interest of the few, not of the folk in general should not be the guiding principle in management of economy and society. 


Haradhan Sarker, PhD, is ex-Financial Analyst, Sonali Bank & retired Professor of Management.


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