Certified Financial Management Specialist Practice Exam

What does capital adequacy ensure for banks?

1. Ability to pay dividends to shareholders

2. Sufficient capital to cover risks

3. Expansion into new markets

4. Openness to international investors

The correct answer is: Sufficient capital to cover risks

Capital adequacy is a critical concept for banks, ensuring that they maintain sufficient capital reserves to cover potential risks associated with their operations and financial obligations. Essentially, it serves as a buffer against unexpected losses that might arise from various risks, such as credit, market, and operational risks. By having adequate capital, banks can protect themselves from insolvency and continue to operate even during adverse financial conditions. This is vital not only for the stability of the individual bank but also for the broader financial system, as a well-capitalized bank is less likely to require a bailout or lead to systemic risk if it faces difficulties. The other options relate to aspects of a bank’s operations or strategic objectives. For instance, paying dividends is a way for banks to return value to shareholders but does not reflect their capacity to manage risks. Similarly, expansion into new markets and openness to international investors pertain to growth strategies and market engagement rather than the fundamental requirement of maintaining sufficient capital to support the bank's financial stability. Thus, the emphasis on sufficient capital to cover risks captures the essence of what capital adequacy is designed to achieve.