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Growth Measures & Capital Adequacy?

Why are we concerned about various aspects of growth and what is its significance when measuring capital adequacy?

Growth in balance sheet size is necessary for banks to meet the growing needs of customers, to offset inflationary pressures on operating costs, and to increase the returns to investors.

Evaluation of growth has several components. First, asset growth compared to the rate of inflation indicates whether the bank is growing in real terms or slipping in relation to changes in the economy.

Second, asset growth indicates how well the management team can do compared to other banks operating in the same environment.

Third, net income growth compared to asset growth indicates whether the bank is sacrificing profitability to achieve rapid asset growth.

Finally, consistency among the growth rates of loans, deposits, assets, and equity (this is the concept of balanced growth) indicates how well management has balanced diverse pressures.

In today’s market environment, maintaining a balance of growth, especially between loans and deposits, is increasingly more difficult due to competitive pressures from other financial institutions and non-bank entities.

As traditional "core" deposits leave the banking system, many bankers have employed available funding programs such as FHLB advances. These programs have allowed bankers to satisfy short-term financing needs or to leverage the bank’s capital position with targeted longer term borrowings to fund specific asset growth opportunities.

If asset growth is more rapid than growth in capital, the bank’s leverage is increased, creating a double-edged sword. From the shareholders perspective, increased leverage is acceptable because it increases their returns per dollar invested. Regulators, however, are critical of asset growth which increases leverage above a conservative level. Balanced growth rates between assets and capital hold leverage constant, therefore, minimizing pressure on the equity to asset relationship.

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