However, banks do not just hold capital to overcome distress, but also because it provides them with financial flexibility. Banks that are strongly capitalized can take advantage of growth opportunities. Also, strongly capitalized banks are better able to promote innovation, whether in the form of new products, new services or new distribution channels. This is not just a capital resource issue, but a human resource issue. Bank managers who are able to focus on the business of banking, strategy and competition, rather than on financial difficulties, can create and innovate and, therefore, add value for shareholders.
Banks also hold capital as a sign of strength to their customers.
Clearly we know this to be true with depositors on the retail side, but it is equally true on the wholesale side. When an institution or corporation enters into letter of credit guarantees or swap contracts, it needs to be confident that its bank will be around in three or five years, at the maturity of the contract. A bank that is well capitalized can credibly state to its customers and clients that it can make good on its promise to pay. More and more, clients recognize this and differentiate among various banks on this basis. As financial services converge and competitive pressures increase, banks find that they must vie for capital, not only with their domestic and foreign counterparts, but also with investment funds, asset management firms, investment banks and insurance companies.