Bank Capital and Profit I am struggling a bit with understanding the meaning of capital ratios, and bank profitablity. It seems to me that capital requirements stipulate that a certain fraction of banks' risk weighted assets have to be held as equity. I get why that is the case: for any given value of assets, having more capital serves as a cushion against their falling values. The definition of bank capital is: $$E=A-L$$

Where E represents bank capital. Now, from a textbook I am reading, it says that banks don't like having high amounts of capital, as it reduces their potential profits. I don't understand what that means- doesn't having high amounts of capital mean that the bank is indeed very profitable (maximizing difference between assets and liabilities?)
Two things:


Capital not being put to work reveals no profit. This capital could have been invested into something else which may (or may not) have resulted in profit for the bank. Opportunity cost of capital could be rather big. This means that the bank is actually loosing out on potential profits.
Capital (in form of equity) does not necessarily mean the company is profitable. Many (often smaller) companies are 100% equity financed - this has no relation to profitability what so ever. Increasing the equity/debt ratio does not say anything about if the company is profitable. It could be because the company has build up equity (yay, this means profits), but it could also be because the company has gotten a capital injection (not affecting profits). It works other ways as well - perhaps a company is very profitable (building equity and not paying dividends), but at the same time they increase their debt, keeping the ratio constant; in this case you cannot see if it is profitable or not. Debt is not the same as “not profitable”. Actually most companies have debt because they may be able to invest the debt at a better rate than their interest rate (eg in machinery to increase production resulting in profits).


Increasing the gap between assets and liabilities is exactly the same as described above. Assets = (Equity + Liabilities).