What bank capital is (simple)
– Bank capital = a bank’s net worth or equity: assets minus liabilities. It is the cushion that absorbs losses and is last in line for payment if the bank is liquidated.
Why it matters
– Banks take deposits and make loans. Because they intermediate other people’s money, regulators require banks to hold capital so losses do not immediately threaten depositors, creditors, or the financial system.
– Regulators monitor capital quality and quantity to judge a bank’s ability to keep operating when it suffers losses.
Key definitions
– Book (shareholders’) equity: the balance-sheet measure equal to assets minus liabilities. Typical components include common and preferred equity, paid‑in capital, retained earnings, and accumulated other comprehensive income.
– Regulatory capital: the measure used by supervisors, defined under international standards (Basel) and local rules. It adjusts book equity for items such as goodwill and intangible assets and classifies instruments by loss‑absorbing capacity.
– Risk‑weighted assets (RWA): the bank’s assets after weighting for credit, market and operational risk; used as the denominator when computing capital ratios.
– Common Equity Tier 1 (CET1): the highest‑quality capital — common shares, paid‑in capital and retained earnings, after prescribed deductions (for example, goodwill and certain intangibles).
– Tier 1 capital: CET1 plus other loss‑absorbing instruments that generally have no fixed maturity, allow cancellation of dividends/coupons, and rank below most debt.
– Tier 2 capital: supplementary capital such as subordinated debt (subject to limits), certain reserves, revaluation reserves and hybrid instruments; it is less reliable for immediate loss absorption.
How regulatory capital is used (brief)
– Capital is expressed as ratios: e.g., Tier 1 capital divided by risk‑weighted assets = Tier 1 capital ratio. Regulators set minimum ratios to ensure solvency buffers.
– Basel III (the most recent international accord) defines capital categories and sets minimum ratio requirements that national regulators implement and often augment with additional buffers.
Practical checklist — how to assess a bank’s capital position
1. Locate the bank’s balance sheet and capital disclosures (quarterly or annual report).
2. Compute or confirm book equity = total assets − total liabilities.
3. Identify CET1 components and deductions (common stock, paid‑in capital, retained earnings; deduct intangibles like goodwill).
4. Find reported Tier 1 and Tier 2 amounts and confirm what instruments are included.
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