Adequate Capital Requirements for Banks

B

The FDIC Payday Lending Guidance is designed to help ensure that banks that offer payday loans do so in a safe and sound manner. Payday loans are short-term, high-interest loans that are typically made to borrowers who have limited access to other forms of credit. These loans can be risky for both borrowers and lenders because they often come with high fees and interest rates and can be difficult for borrowers to repay.

To address these risks, the FDIC has established guidelines for banks that offer payday loans. One of the key guidelines is that banks should hold adequate capital against their subprime portfolios. Capital is the amount of money that a bank has available to absorb losses. Holding adequate capital helps to ensure that a bank can continue to operate even if it experiences losses on its loans.

The question asks about the amount of capital that banks should hold against their subprime portfolios. The correct answer is B. Banks should hold capital against their subprime portfolios in amounts that are 1½ to 3 times greater than normal. This means that if a bank has a normal capital requirement of, for example, 10%, it should hold between 15% and 30% capital against its subprime loans.

The reason for this higher capital requirement is that subprime loans are riskier than other types of loans. Borrowers who take out payday loans are often already in financial distress and may have difficulty repaying their loans. This increases the risk of default and loss for the bank. By holding more capital against its subprime loans, the bank can better absorb losses and continue to operate even in the face of significant loan losses.

In summary, the FDIC Payday Lending Guidance requires banks to hold adequate capital against their subprime portfolios. The amount of capital that banks should hold is 1½ to 3 times greater than their normal capital requirements, in order to offset the higher risks associated with payday loans.