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PAST TREND OF THE CAPITAL RATIO

Summary of Remarks

fcy
Tynan Smith
Division of Research and Statistics

Before
FDIC SUPERVISING EXAMINERS

Washington, D. C




April

22 , I9I4.6

PAST TREND OF THE CAPITAL RATIO
By Tynan Smith

Although we have been keenly aware in the last five years of the
declining capital ratio, there has been a fairly steady downward trend for
a long time.

In 1875 the average capital ratio for all operating banks in

the United States was about 35 percent.

It fell to about 30 percent in

the next five years and remained at about that figure until 1895#
the business upturn of

1897

During

to I899, the average capital ratio for all

operating banks showed one of the sharpest declines on record and fell
from 26 percent to 20 percent#
a

31

This decline was almost entirely due to

percent increase in bank assets.

The ratio then fluctuated arouijd

the 20 percent level until the First World War.

1875

to

1915 #

In the k0 years from

the capital ratio was cut nearly in half, from

to 16 percent*

35

percent

This decline reflected the more rapid increase in bank

assets— which grew ten-fold during the forty years whereas bank capital
increased about

five times the

1875

total*

The two accompanying charts show the trend for the last three
decades in the capital ratio and in total bank assets of all Operating
bonks.

During the First ?forld War the rapid growth in bank assets

brought a substantial decline in the capital ratio.

From June

1915

to

June 1919 assets increased about 70 percent, while capital increased
about 20 percent and the ratio fell from 16 percent to 11 percent#
the postwar depression of




1920-21

In

bank assets declined while bank capital

,2-

incroasod and tho ratio rose to 13 percent in June 1921*

1925,

From 1922 to

assets again grew more rapidly than bank capital and the ratio

gradually foil#

However, from 1925 to 1930 the reverse was true, and

capital grew at a faster rate than bank assets#

In June 1930, bank

assets reached a peak of $ 7^4- billion dollars while bank capital totaled
$10g- billion— giving a ratio of a little over II4 percent#
When banking difficulties become serious in tho early thirties,
both bank assets and bank capital declined, but assets shrunk more rapidly
than did capital so that the ratio rose and reached a peak of
in June 1932#

14,500

percent

Between the middle of 1932 and the middle of 1933 about

banks went out of business#

lion from the

15

1930

Total bank assets declined to $51 bil­

peak of $ 71+ billion and total capital accounts fell

from $ 10*5 billion in

1930

to $7»U billion in the middle of

1933»

From the time the program to rehabilitate the Amerioan banking
system got under way in late
an almost continuous growth#

1933

to the present, bank assets have shown

The only exception was during the business

dip in 1938 when there was a slight contraction of bank assets#

Bank

capital has followed a similar pattern, but the growth has been at a
lower rate#

As a consequence, the capital ratio has declined steadily#

This decline was accelerated by the sharp upturn in bank assets during
the war#

Total bonk assets more than doubled from the middle of I9I4O

to the end of 19U5, while bank capital increased about
this period tho capital ratio dropped from




10#3

25

percent to

percent#

5*9

In

percent#

-3-

The long-run downward trend in the capital ratio has occurred
despite a remarkably steady growth in the dollar amount of bank capital*
Bank capital has increased in amount each year for the past JO years with
few exceptions»

There were moderate decreases in the years 1878 to 1880

and again in tho 1896-97 business depression»
was not until

1930-1933

The next period oi* decline

when bank capital decreased about

30

percent*

Recently we have heard a great deal about another kind of capital
ratio, namely, the ratio of capital to so-called wriskM assets*

Risk

assets are generally defined as assets other than cash'and U* S* Govern­
ment obligations»

The current interest in this capital ratio is in part

the result of the tremendous increase in bank holdings of TJ» S* Govern­
ment obligations during the war, and in part this ratio is being used to
counteract the criticism being directed against the rapidly declining
ratio of bank capital to total assets*
Although there was some increase in the ratio of total capital
accounts to total assets other than cash and Governments during the war,
the rise was not as great as most people believe and the ratio has now
returned to approximately its prewar level*

This ratio has been more

stable than has the ratio of capital to total assets and in the last

10

years there has been surprisingly little change in the ratio of capital
to so-called T,riskM assets*

In 1875 this ratio was about 55 percent»

During the next I4.O

years, the trend of this ratio was generally downward, and in 1 9 1 5




it

was

21

peroont»

In the

1920*s

when bank loans were expanding rapidly, the

ratio of capital to total assets other than cash and Governments declined
to about
June

15

193U the

rose to

27

1926,

percent in
ratio was

percent in

25 percent.

23

19U 3

but by

1929

it had risen to

percent and in June
but by the end of

1939

19U 5

17

it was

percent«

25

In

percent»

It

it had returned to about

Should bank loans incroaso substantially in the future, we

can expect a further decline in this ratio»
It is interesting to note that during the First World War the
ratio of capital to assets other than cash and Governments declined whereas
in this war it rose#

The difference was caused by the variation in the

method of financing the industrial expansion needed to carry on the two
wars#

In the last war the banks had a major part in financing the indus­

trial expansion* and with bank loans increasing,the ratio of capital to
risk assets declined#

This time, however, the bulk of the industrial ex­

pansion was financed directly by the Government and only indirectly by
the banks through their purchase of Government securities#
was an increase in so-called riskless

The result

..assets held by the banks»

Since

bank loans and investments of securities other than U# S» Government ob­
ligations remained relatively stable while bank capital rose, the ratio
to so-called risk assets increased#
The current interest in the ratio of bank capital to so-called
"risk” assets is just one aspect of the point of view that favors relating
bank capital to the quality of bank assets»

At the present timo, bank

assets are of the highest q uality and appear to entail very little risk»




-5-

This fact is used to argue that the declining trend in the ratio of capital
to total assets is not serious and that our banking system can operate
safely on a capital ratio less than half the

1929

figure*

It is* however*

questionable how far such an argument can be carried* particularly when
the capital ratio appears to be rapidly approaching the zero point*
Bank capital is chiefly important from a supervisory viewpoint
as a cushion against asset depreciation*

The question of the quality of

bank assets is primarily a problem of the examination program*

It is up

to the examiners to discover substandard assets and to attompt to take
corrective action*

But even after the most careful Examination* there

remains an irreducible minimum of uncertainty«

The quality of bank

assets is susceptible to rapid and unpredictable changes«

Therefore*

capital must be provided as protection against the uncertainty which
remains in a bank whose assets contain no measurable risk of loss»




PERCENTAGE OF TOTAL CAPITAL ACCOUNTS TO TOTAL
ASSETS OF ALL OPERATING BANKS, 1915-1945

Percent

20




(June Call Dates)

Percent

20