How Bank Deposits Affect WACC and Regulatory Capital
Summary
The discussion examines whether customer deposits should be included as debt when estimating a bank’s weighted average cost of capital. One answer argues that deposits should be excluded when valuing a parent bank whose financing consists of equity and issued debt. Another distinguishes the parent from its deposit-taking subsidiary: the parent may exclude deposits, while the regulated subsidiary’s capital structure includes them and can have a different cost of capital.
The answers also distinguish funding liabilities from regulatory capital. Deposits are generally not treated as capital under the Basel framing described, whereas common equity, retained earnings, and qualifying subordinated instruments can count toward regulatory capital. These are contextual views rather than a universal WACC rule; the appropriate treatment depends on which legal entity is being valued and how its financing is defined.
Key ideas
- Whether deposits belong in WACC depends on the bank entity being analyzed.
- A parent bank that issues equity and unsecured debt may have a different capital structure from its deposit-taking subsidiary.
- Customer deposits are liabilities and generally are not regulatory capital under the discussion’s Basel framing.
- Equity, retained earnings, and qualifying subordinated instruments can contribute to regulatory capital.
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Full text
# Calculation for WACC for commercial banks # Calculation for WACC for commercial banks Commerical banks have a large weightage of debt from deposits, which has a very low interest rate. This caused our calculated WACC to be very low. Is this correct? https://docs.google.com/spreadsheets/d/1Cq2qiVEetbNP65fYnxYvJsfViBKLNT8p5GW0GkMkhGc/edit#gid=416987316 Or should we omit customer deposits from our calculation of WACC? Sites like Gurufocus cite a more reasonable value for WACC at around 5% - 12%, which disagrees with our calculations. ## Answer by ZRH (score 1, accepted) https://quant.stackexchange.com/a/44855 You should definitely omit deposits in my view. The calculation of WACC is based on equity capital and debt capital that a firm uses to fund itself. Banks are not allowed to use customer deposits to fund themselves (I think you would not agree that your local bank uses your deposits to fund itself, while paying you sub 1%) ## Answer by dm63 (score 2) https://quant.stackexchange.com/a/44864 It depends what you meant by “bank”. For example in the case of Bank of America, the deposit taking entity is Bank of America NA (BANA) which is a wholly owned subsidiary of Bank of America Corp (BAC). The latter does not take deposits , but it issues most of the unsecured debt and it is the issuer of the listed equity of the company. Hence the WACC of BAC does not contain deposits. The WACC of BANA does contain deposits, and it is a highly regulated entity with a lower WACC than BAC. ## Answer by Attack68 (score 0) https://quant.stackexchange.com/a/44869 The traditional definition of "capital" is that used by Basel for regulatory purposes. In this sense retail (or commercial) deposits are not capital. Capital is generally speaking ordinary share capital plus retained earnings. A bank can acquire new regulatory capital by issuing new equity or witholding dividends and therefore retaining more cash as earnings. Additional Tier 1 Capital can be acquired by raising funds through T1 bonds, which are sufficiently subordinated debt as permitted by Basel. Retail (or commercial) deposits are no where near subordinated enough to be classified as capital. Plus they are technically, immediately due liabilities meaning the notion of them being treated as capital is frivolous since a simple bank run would deplete this resource.
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