The company may, voluntarily or by force of law, over a period of years add to the original capital contributions by withholding part of its earnings, not declaring them in dividends and converting them into a "surplus" fund. The state law, as a protection to the bank's creditors and as a means of adding to the stability of financial institutions, may require that the bank accumulate a surplus equal to, say, 40 per cent of its capital and that a certain fraction of the yearly earnings be diverted to that fund until it is filled. To make their bank's statement somewhat more comparable to those of other institutions, and also to reduce the extra liability that may attach to stock ownership, the founders of the bank may start with a capital of $100,000 and a surplus of $100,000 rather than with a capital of $200,000. The surplus accumulated in an old bank may be many times its capital.

Public policy requires that capitalization bear a rough proportion to the size of the business done; and, since size of business is roughly proportional to the population of the domiciling city, the state and federal laws have fixed the minimum capitalization of banks in various sized cities.

The existence of a fair-sized surplus also promotes stability in corporate control. If in bad years net operating deficits had to be met by assessing the stockholders rather than by using up the surplus, the wealthy stockholders would be at an advantage over the poorer, who would find it difficult to meet the assessments. In fact the corporation might fall into the control of unscrupulous men who would purposely operate it at a deficit in order to "freeze out" the weak stockholders. This operation, however, is less likely to succeed if a large surplus must be exhausted before assessments can be put on stockholders.

To maintain a working balance, the bank does not declare all its earnings as dividends nor convert them into surplus, but retains a relatively small amount as "undivided profits." The capital, surplus, and undivided profits represent the original and accumulated contributions of the owners of the bank, and serve as a buffer to reinforce the claims of the bank's creditors. These contributions, along with the funds contributed by creditors, are invested in various assets, only a small part of which is held as cash reserve.

It is wholly wrong to think that surplus and undivided profits constitute a fund of cash in the bank, or any other particular form of assets. The surplus together with the undivided profits is a property right (in proportion to the shares owned) of the stockholders in the general assets, and as such is a valuation item in the financial statement. The accumulated aggregate assets have a book valuation more or less equal to the market valuation. This book valuation, less the creditor liabilities and the capitalization, is the surplus. If the book valuation exceeds the market valuation, the surplus is not substantial; on the other hand, if the assets are undervalued, the bank creditors have more protection than is shown. Capital and surplus protect depositors and noteholders, for in case of liquidation the greater the actual value of the assets belonging to stockholders the more are the funds that can be realized for the bank's creditors.