Capital Loss Coverage Ratio

The difference between an asset’s book value and the amount received from a sale relative to the value of the nonperforming assets being liquidated. The capital loss coverage ratio is an expression of how much transaction assistance is provided by a regulatory body in order to have an outside investor take part.

Capital loss coverage is a form of regulatory commitment made to investors in order to entice them to purchase assets once held by liquidated banks and other financial institutions. It is a form of transaction assistance provided by bank regulators, such as the Federal Deposit Insurance Corporation (FDIC). Using an assisted transaction is thought to help maintain a level of goodwill, and presents less downside risk to outside investors by substituting an immediate cash payment with a different type of financial arrangement.

During the 1980s, the FDIC and the Federal Savings and Loan Insurance Corporation (FSLIC) were charged with resolving thrifts and banks that had failed or were in risk of failing. In addition to capital loss coverage, the FDIC, through the Resolution Trust Corporation (RTC), also provided cash, regulatory forbearances, and other agreements in order to prop up the banking industry. By using a variety of financial arrangements to entice investors, regulators were able to wind down more failed financial institutions than if they had relied solely on liquidations.

Companies are willing to invest in insolvent thrifts and banks because they may be able to purchase assets, such as real estate holdings, more cheaply than if they were competing on the open market. They know that regulators would prefer to wind down failed financial institutions as quickly as possible so as to help local communities recover and regain trust, which allows investment companies to extract more concessions from groups such as the FDIC and FSLIC.