Bank solvency or how prudent banks truly are

We keep hearing lately with an increasing frequency comments on the solvency ratio of Romanian banks. Even representatives of the National Bank of Romania (Romania"s central bank) said that the solvency ratio of the domestic banks is very good, going as far as 12 - 12.5%. Reading such news can only make us happy, but what exactly is the solvency ratio and how do we actually calculate it?

The European Solvency Ratio (ESR) is the best known index which measures bank prudence and has the main purpose of guaranteeing the ability of the banking institutions to handle a situation where its debtors would go bankrupt and to eliminate competitive discrepancies between the various national banking systems.

The ESR is determined as a percentage ratio between a bank"s own funds, on one hand, and the assets found in the balance sheet and assets moved off the balance sheet weighted with a risk ratio, on the other hand.

The bank"s own funds considered in the calculation of the bank"s solvency are divided across two categories: basic own funds (capital and reserves) and complementary own funds (revaluation reserves, subsidies).

These two categories of own funds must be balanced, more specifically, the amount of complementary own funds must be lower than the one of basic own funds.

The most interesting part in the procedure for determining a bank"s solvency is the weighting of the bank"s assets by a certain risk ratio. This coefficient varies between 100% for loans and 0% in the case of receivables against the state and against the governments of developed countries.

The European Solvency Ratio was defined by the European Commission in 1989, and later, in the years 1991-1995, were issued compliance and application instructions.

Currently, the minimum levels of a bank"s solvency is 8%, and the fact that Romanian banks beat this ratio by 4 percentage points can only give us confidence that, (at least according to reports), Romania"s banking system is solid.