Equity Capital as a Safety Cushion in the US Banking Sector

The incidence of US bank failures soared in the financial crisis and economic recession starting in 2008. Financial regulations promulgated by the Federal Reserve and issued through the Basel III Accord raised the minimum equity capital requirements of banks. The intent of the increase in equity capital was to serve as a greater safety cushion to reduce the probability of failure. The purpose of this study is to examine the financial statement variables that distinguish failed (zero equity capital) and nonfailed US banks. The methods employed to investigate our research question are: 1. univariate t-test, and 2. tobit regression analysis with equity capital as the dependent variable. Our results show that the factors explaining equity capital include real estate loans to assets, equity capital to total assets, log of total assets, return on equity, loan loss allowance to total loans, non-performing loans to total assets, total loans to total assets, mortgage-backed securities to total assets, total short-term debt securities to total assets, net gains on sales of loans to total non-interest income, and insured deposits to total deposits. Bank management and financial regulators need to focus on these financial characteristics to ensure adequate equity capital as a safety cushion.