Banks are usually integration. On this foundation therefore, they require a certain amount of capital in terms of money and other assets to stabilize. Governed by banking laws, each bank must acquire a certain amount of capital for its smooth function. This capital is acquired through the selling of capital stock to shareholders. Shareholders receive a certificate that acts as proof for their ownership of specific stock in the bank. This money that the shareholders buy is translated as the working capital of the specified bank. A trust fund is used to store this capital as a way of protecting the bank’s depositors. This working capital should rotate within the bank and should never be diminished. Dividends to shareholders therefore are paid through the profits or surplus capital of the bank. Shareholders are considered not liable for the debts and acts of a bank (Thorsten, Asli & Ross, 2000).
Leverage generally refers to borrowed funds to finance assets such as to purchase inventories or company equipment. Using debts, or what is termed as leverage, renders the company susceptible to bankruptcy. It however increases the company’s returns especially equity. This is because it prevents the dilution of owner’s equity when there is issuing of more shares of stock. In addition, whether the interest charges are from credit or loan, tax has to be deducted from the interest. It also helps a company in the establishing of a confident payment history and a positive rating in the business credit. However, a certain level of debt financing results to investors losing faith as this drives a company’s default risk up. Operating leverage can be established by the ability of a firm to equate their fixed costs against variable costs. A high operating leverage makes a company very sensitive to changes. This is because it affects the company’s bottom line. Bottom line profits refer to net profits after all the costs of the business have been accounted for (Brent & Timothy, 2002).
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A bank business risk can be defined as the risk that the shareholders in a certain have to face due to the absence of debt. It is caused by economic uncertainties surrounding the current prospect of a business which in return creates fears in future profits and capital requirements. Banks control different kinds of risks through different kinds of management measures. The use of diversification across their branches and the use of medium sized clients act as a control measure for credit and country risk. Counterparty or issue risk is controlled by avoiding securities with a rating below AA-. Liquidity risk can be controlled by defining very conventional stress tests and the maintenance of an adequate liquidity reserve, including the possible worst cases. Operational and money laundering risks can be controlled by focusing on staff quality and systems quality (Brent & Timothy, 2002).
Financial intermediaries help in the channeling of funds from people who have excess capital to those who require liquid funds. It can as well be an establishment that enables the conducting of funds between lenders and debtors indirectly such as banks. This could be in form of finances, credits or mortgages. They are responsible for the transformation of short term liabilities to long term assets. They as well look into risky investments and transform them to comparatively risk ones. This could be achieved by the lending of the money to a couple of borrowers to reduce risks. They help in the matching of small deposits with large loans and consequently large deposits with small loans. This is also referred to as convenience denomination. They are usually cost advantage comparing to direct borrowing or lending. Financial intermediaries protect the market failing due to reconciling of lenders and borrowers conflicts (Gahir, 2009).
References
Thorsten, Beck., Asli Demirguc-kunt. & Ross, Levine. (2000). “A New Database on Financial Development and Structure,” World Bank Economic Review , 14, 597-605.
Brent, Gloy. & Timothy, Baker.(2002). The Importance of Financial Leverage and Risk Aversion in Risk-Management Strategy Selection. American Journal of Agricultural Economics , 84 (4), 1130-1143.
Gahir,Bruce. (2009). Financial Intermediation . Prague: Czech Republic.
