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Managing Extreme Financial Risk by Karamjeet Paul

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Chapter 11

Paradoxical Capital Problem

Abstract

The banking industry has a paradoxical capital problem. There is tremendous pressure to increase the capital base. However, simply adding more capital is not an effective solution. Getting more capital does not address the problem because new capital requires higher earnings to cover the incremental cost of capital. The quest for higher earnings requires taking on more risk because that's what drives the revenue model. Higher risk translates into pressure for more capital. Hence the paradox: Adding capital actually increases the need for more capital. Also, it is questionable if the industry can easily obtain the huge amounts of incremental capital projected by various capital models to meet ...

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