Analysis of asset quality

Risk Assets

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Analysis of Capital

In general terms, the function of bank capital is to support the volume, type and character of the bank's business, to provide for the possibilities of losses that may arise, and to enable the bank to continue to fulfill the reasonable credit needs generated within the community that it serves. Inasmuch as it is generally agreed that depositors are not meant to assume risks emanating from the operation of the bank, capital should be sufficient to absorb shrinkage in asset value and other losses that may be incurred.

The risk asset ratio is an objective measure of the amount of shrinkage that can be absorbed by a bank's capital structure and is to be used in rating bank capital. This ratio defines the relationship of gross capital to those assets which contain some potential for loss (i.e. risk assets) without attempting to specify the loss inherent in any given risk asset or risk asset category.

The risk asset ratio is calculated from the bank's most recent Consolidated Report of Condition (including foreign and domestic subsidiaries, when applicable) and is defined as follows:

Risk Asset Ratio = Gross Capital Funds

The term gross capital funds includes total equity capital, the reserve for possible loan losses and subordinated notes and debentures. Risk assets are defined as total assets plus reserve for possible loan losses less cash and due from banks, U.S. Treasury securities, obligations of U.S. Government agencies, trading account securities, and Fed funds sold and securities purchased under agreements to resell.

Since the risk asset ratio does not distinguish the degree of risk associated with differing asset structures, it is to be used in tandem with the quality of assets rating to arrive at the final rating of bank capital. The following tables provide the ratio guidelines and the limiting conditions, which are to be used in arriving at the overall capital rating.

In rating asset quality, the system is designed to distinguish the degree of risk inherent in classified assets by ascribing weights to each category of classification, thereby providing a more reliable measure of the impact of risk on bank capital.

The following weights are to be used:

Classification	Weights
Substandard Doubtful Loss	20% 50% 100%

Total weighted classifications equal the aggregate of 20 percent of assets classified substandard, 50 percent of doubtful and 100 percent of loss.

The ratio of weighted classifications to gross capital funds (as defined above) is the primary criterion to be used in determining the quality of assets.

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