IX. Write a memorandum.

You work for a bank which performance is being supervised. Your Financial Manager, Charlotte Ameasbury, has asked you to represent her at a meeting and let her know what you said. The meeting was between you, Karl Brewer, working for the Financial Department and Mr. John Cannon, your bank’s supervisor. The main discussion went as follows.

Mr. Cannon:	We look at capital as the main source of protection for depositors. A well-capitalized bank can absorb large losses without the depositors losing their money. To evaluate your bank’s capital adequacy, we primarily rely on ratios. But before a ratio can be calculated, we must define capital, meaning what types of accounts can be used as capital.
Karl:	We recognize as capital paid-up capital by shareholders, share premiums on capital, retained profits, and general or legal reserves. We sometimes call it core capital.
Mr. Cannon:	I’d like to clear out the issue of supplementary capital. Judging from the documentary data it includes revaluation reserves on fixed assets, unencumbered general provisions for future loan losses, and various types of debt instruments which can be subordinated to the interests of the depositors.
Karl:	So, once capital is defined, a choice is to be made as to what it is compared to. Traditionally it has been deposits or more recently total assets.
Mr. Cannon:	Let us agree on capital measured against the risks your bank assumes, both on and off its balance sheet. As a result, a simple gearing or leveraging ratio of capital to total deposits or total assets has been replaced by a risk-based method.
Karl:	But let us leave this question and turn to it when Mrs. Ameasbury joins us.

Your task is:

1) Write a suitable memo to the Finance Manager in accordance with her instructions.

2) Prepare some theoretical material on asset quality to be ready to the supervision of your bank and discuss it with Charlotte.

A major part of bank supervision is determining asset quality, which includes which assets are uncollectible or whose true value is less than shown on the bank’s books.

· To rate asset quality, it is usually necessary for an on-site examination to be done.

· Examiners who are well trained in evaluation of advances and other credit facilities will assign a classification to the problem loans based on analysis of collectibility.

· The classification system of substandard, doubtful, and loss enables the supervisor to quantitatively determine a bank's overall asset quality rating in the CAMEL system, and to judge the adequacy of the provisions for loan losses.

· It is essential to remember that while submitted returns can give some indicators of asset quality, a true and thorough evaluation of it comes from on-site examinations done by examiners trained in credit analysis.

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