Michigan's banking law requires each bank to maintain an adequate capital structure appropriate for the conduct of its business and protection of depositors (Section 71(3) of the Banking Code of 1969). Bank directors have the primary responsibility for insuring that an adequate capital structure is maintained.

Capital is one of the principal buffers against risk. Periodically, the Bureau will evaluate a bank's capital structure and make appropriate comment in those instances where it is felt that the existing capital levels are inadequate. In conducting our evaluation the following factors are generally considered:

MANAGEMENT: The ability, attentiveness, integrity, and record of management, together with the soundness of its policies are of major importance. Sound management, prudent policies, and effective operating procedures are key elements in the overall risk equation of the bank's business and, therefore, must be considered when judging capital adequacy.

ASSETS: The general character, quality, diversification, and liquidity of the bank's assets, with particular attention to assets which are adversely classified, are vital factors in determining the adequacy of the bank's capital.

EARNINGS LEVEL AND TREND: Retention of profits has historically been the principal means of augmenting bank capital; thus there is a direct relationship between the bank's ability to generate satisfactory earnings, maintain reasonable dividends and the adequacy of its capital. Indeed, earnings are of primary importance in the analysis of the bank's overall condition because they reflect the composition and performance of every phase of the business conducted by the bank. Earnings are the lifeblood of the bank and require constant attention not only in connection with capital adequacy, but also as a separate and individual subject.

COMMUNITY SERVICE: The capital accounts must also be analyzed and appraised with due regards to the bank's capacity to furnish the broadest service to the public.

LOCAL CHARACTERISTICS: The general type of clientele, the stability and diversification of the local economy and the bank's competitive situation are significant factors in the determination of capital adequacy.

LIABILITY STRUCTURE AND DEPOSIT TRENDS: The adequacy of the bank's capital must also be assessed in relation to the composition of its total liabilities. Particular attention should be accorded to the volatility of deposits, and the bank's growth experience, plans, and prospects.

AUDIT, INTERNAL CONTROLS, AND INSURANCE: The quality of audit programs, internal operating procedures and the amount of the bank's insurance protection must be considered when evaluating capital sufficiency.

FIDUCIARY BUSINESS: The volume and nature of the business transacted in a fiduciary capacity are important factors when determining capital needs.

COMPARATIVE RATIOS: Ratios are simple, usually objective measures of a bank's condition. They provide one means of measuring an institution's relative performance. However, they have frequently proven to be over-simplified tools when used as the sole criteria for evaluating capital adequacy. They are most effective as rough benchmarks. Commonly used ratios in the analysis of capital adequacy include: return on assets and equity, capital/assets, capital/risk assets, loans/deposits, classified assets/capital and reserves, and liquidity.

GENERAL CONTINGENCIES: The possibility of lawsuits, uninsured defalcations, or other unforeseen losses, should be considered in the determination of appropriate capitalization.

HOLDING COMPANY CAPITAL: Where applicable, a review of the condition and activities of a bank's parent holding company and other subsidiaries must be undertaken to arrive at valid conclusions pertaining to an individual bank s capital adequacy and earnings. Experience has proven that it is nearly impossible to insulate an individual bank from problems that may be encountered by its affiliates.

SUBORDINATED DEBT: The Bureau will continue to give consideration to capital debt in our appraisal of capital. The maximum acceptable ratio of debt to total capital will continue to be 25%. A requirement for subordinated debt obligations to be considered capital is the ability of an institution to provide reasonable projections that the debt issue can be invested in assets and support liability growth which will contribute to retained earnings an amount equal to or greater than the principal amount of the debt.

Signed:	Martha R. Seger, Ph.D., Commissioner
	Gifford Knudsen, Director, Bank & Trust Division
Dated:	August 31, 1981