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Author Beverly Hirtle, vice president in the Banking Studies area, explains that since the late 1980s and early 1990s U.S. bank holding companies have greatly increased their capital ratios--the mandated ratios designed to gauge capital strength. Today, owing largely to a string of highly profitable years, nearly all banking institutions have capital ratios that comfortably exceed the regulatory minimums.
Despite the present healthy state of capital ratios, 1997 did see average ratios at U.S. banking institutions decline sharply, especially among the largest institutions. This drop could cast doubt on the institutions' future capital strength, particularly if their credit quality deteriorated significantly or if profitability otherwise weakened. Such capital constraints could undermine banks' ability to expand their lending activities or participate fully in other key financial services.
Hirtle assesses the seriousness of these concerns by examining the reasons for 1997's fall in bank holding company capital ratios. She concludes that such concerns may be premature, based on her findings that:
The drop in average capital ratios is due mainly to large banking companies' strategy of managing their capital positions by returning earnings to shareholders, rather than to an unusually large rise in risk-weighted exposures.
Following a period of strong, sustained profitability, bank holding companies greatly increased their payouts to shareholders in 1997, in the form of dividend payments and stock repurchases.
Most of the increase in shareholder payouts resulted from a surge in stock repurchases; significantly, if future earnings do begin to fall, banks can cut back on repurchases more easily than they can reduce dividend payments.