What is 'Bank Capital'

Bank capital is the difference between a bank's assets and liabilities, and it represents the net worth of the bank or its value to investors. The asset portion of a bank's capital includes cash, government securities and interest-earning loans, such as mortgages, letters of credit and inter-bank loans, while the liabilities section of a bank's capital includes loan-loss reserves and any debt it owes. A bank's capital can be thought of as the margin to which creditors are covered if the bank liquidates its assets.

BREAKING DOWN 'Bank Capital'

The bank capital represents the value of a bank's equity instruments that can absorb losses and have the lowest priority in payments, if the bank liquidates. While the bank capital can be defined as the difference between a bank's assets and liabilities, national authorities have their own definition of regulatory capital. The main banking regulatory framework consists of international standards enacted by the Basel Committee on Banking Supervision through international accords of Basel I, Basel II and Basel III. These standards provide a definition of the regulatory bank capital that market and banking regulators closely monitor.

Book Value of Shareholders' Equity

The bank capital can be thought of as a book value of shareholders' equity on a bank's balance sheet. Because many banks revalue their financial assets more often than companies in other industries that hold fixed assets at a historical cost, shareholders' equity can serve as a reasonable proxy for the bank capital. Typical items included in the book value of shareholders' equity include preferred equity, common stock and paid-in capital, retained earnings, and accumulated comprehensive income. The book value of shareholders' equity is also calculated as the difference between a bank's assets and liabilities.

Regulatory Bank Capital

Because banks serve an important role in the economy by collecting savings and channeling them to productive uses through loans, the banking industry and the definition of bank capital are heavily regulated. While each country can have its own requirements, the most recent international banking regulatory accord of Basel III provides a framework for defining regulatory bank capital.

According to Basel III, the regulatory bank capital is divided into different tiers based on subordination and the ability to absorb losses with sharp distinction of capital instruments when a bank is still solvent versus after it goes bankrupt. Common equity tier 1 (CET1) includes the book value of common shares, paid-in capital, retained earnings, less goodwill and any other intangibles. Instruments within CET1 must have the highest subordination and no maturity.

Tier 1 capital includes CET1 plus other instruments that are subordinated to subordinated debt, have no fixed maturity and no embedded incentive for redemption, and for which a bank can cancel dividends or coupons at any time. Tier 2 capital consists of unsecured subordinated debt and its stock surplus with original maturity of less than five years minus investments in non-consolidated financial institutions subsidiaries under certain circumstances. The total regulatory capital is equal to the sum of Tier 1 and Tier 2 capital.

RELATED TERMS
  1. Basel III

    A comprehensive set of reform measures designed to improve the ...
  2. Basel II

    A set of banking regulations put forth by the Basel Committee ...
  3. Tier 1 Capital

    A term used to describe the capital adequacy of a bank. Tier ...
  4. Tier 2 Capital

    One of two categories by which a bank's capital is divided. Tier ...
  5. Tier 1 Leverage Ratio

    The relationship between a banking organization's core capital ...
  6. Basel I

    A set of international banking regulations put forth by the Basel ...
Related Articles
  1. Investing

    The Legacy of Basel I

    Basel I refers to a set of international banking rules enacted in 1988 by the Basel Committee on Bank Supervision.
  2. Investing

    How Basel 1 Affected Banks

    This 1988 agreement sought to decrease the potential for bankruptcy among major international banks.
  3. Personal Finance

    Is Your Bank On Its Way Down?

    Find out how the Tier 1 capital ratio can be used to tell if your bank is going under.
  4. Investing

    Basel II Accord To Guard Against Financial Shocks

    Problems with the original accord became evident during the subprime crisis in 2007.
  5. Investing

    What is Basel III?

    The purpose of the Basel accords is to improve the worldwide bank regulatory framework.
  6. Personal Finance

    Explaining Tier 1 Capital

    Tier 1 capital refers to the core capital a bank must maintain in relation to its assets.
  7. Investing

    Using Economic Capital To Determine Risk

    Discover how banks and financial institutions use economic capital to enhance risk management.
  8. Investing

    Understanding The Basel III International Regulations

    The Basel III regulations mark a drastic reform in international banking. But how do they impact the future's investment landscape?
RELATED FAQS
  1. If my brother-in-law, who works at a pharmaceutical company, tells me about his research ...

    Discover what tier 1 capital measures about a bank. Tier 1 capital levels were mandated by Basel III following the financial ... Read Answer >>
  2. What percent of capital should banks hold relative to its risk weighted assets?

    Learn what percentage of capital banks must hold under the capital adequacy ratio as set forth in Basel III, and understand ... Read Answer >>
  3. How can I calculate the tier 1 capital ratio?

    Learn about the tier 1 capital ratio, what the ratio indicates about a firm's capital adequacy and how to calculate a firm's ... Read Answer >>
  4. Why is the capital adequacy ratio important to shareholders?

    Understand what the capital adequacy ratio is and why it is a very important metric of financial soundness for evaluating ... Read Answer >>
  5. Are a bank's current assets counted as liquidity?

    Find out how bank assets are defined and how the Federal Reserve controls the definitions of, requirements for, and availability ... Read Answer >>
Hot Definitions
  1. Fixed Cost

    A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
  2. Blue Chip

    A blue chip is a nationally recognized, well-established, and financially sound company.
  3. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
  4. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  5. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  6. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
Trading Center