Should Equity be an Element of a Funding composition plan ?


There was a debate if Equity should be included in a Funding Composition schedule of a financial institution. The Plan is composed in the following sections.

Funding from Private Sector (deposits, repos, etc)

Funding from Central Banks

Since equity is funding that comes from shareholders shouldnt it be a part of the Funding Composition schedule, as a third pillar ? If not what is the reasoning ? If it is a form of funding but it should not not part of a funding composition schedule of a financial institution what is the rationalle ?

Thank you in advance

Sure. The thing about equity is that it can be (nearly) wiped out and the entity (a bank) can still remain in business. If equity goes below zero, that means that debt obligations are likely to be defaulted on. So equity basically gives some “wiggle room” between operating profits (in banks, net interest margin + fees) and interest payments so that the business can survive a bad period or two without going belly-up.

The interesting thing is the central bank. Equity ownership generally gives control rights as a compensation for the lack of guarantees that bondholders have re interest and principal payments. So in the case of a central bank, who controls the equity and what rights come with it is a bigger debate. The US Federal reserve is technically owned by its member banks who contribute capital, which is one reason that I think some of the complaints about bankers being on the board of directors is not as valid as it sounds on the surface. There is a conflict of interest there, to be sure, and a temptation to use that role to benefit member banks or front run the entire economy, but it is also true that these members have contributed capital; there is a reason they are entitled to be there.

There’s a different concern over central banks and equities, which is about what goes on the bank’s balance sheets, and whether central banks ought to be investing in the stock market. I generally think that’s a bad idea, because central bank balance sheets should have fairly non-risky assets, because the form the things that back the money supply. You don’t want your currency backed by stocks that can go to zero or even lose half their value in 6 months. Admittedly, banks that own only a few stocks probably can avoid that problem, particularly if they have enough book equity, but then you also raise the question of whether it is appropriate for central banks to intervene to set the value or direction of the stock market.