Capital Buffer

Definition of 'Capital Buffer'


Mandatory capital that financial institutions are required to hold in addition to other minimum capital requirements. Regulations targeting the creation of adequate capital buffers are designed to reduce the procyclical nature of lending by promoting the creation of countercyclical buffers.

Investopedia explains 'Capital Buffer'


Capital buffers identified in Basel III reforms include countercyclical capital buffers, which are determined by Basel Committee member jurisdictions and vary according to a percentage of risk weighted assets, and capital conservation buffers, which are built up outside periods of financial stress.

Banks expand their lending activities during periods of economic growth, and contract lending when the economy contracts. When banks without adequate capital run into trouble they can either raise more capital or cut back on lending. If they cut back on lending, businesses may find financing more expensive to obtain or unavailable at all. 

The 2007-2008 financial crisis exposed weaknesses in the balance sheets of many financial institutions across the globe. Bank lending practices were risky, while bank capital was not always enough to cover losses. Some financial institutions became known as “too big to fail” because they were systemically important. To reduce the likelihood of banks running into trouble during economic downturns, regulators began requiring banks to build up capital buffers outside periods of stress.

To give banks enough time to create adequate capital buffers, Basel Committee member jurisdictions announce planned increases twelve months in advance. If economic conditions allow a decrease in required capital buffers those reductions take place immediately.



comments powered by Disqus
Hot Definitions
  1. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  2. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  3. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  4. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
  5. Yield Burning

    The illegal practice of underwriters marking up the prices on bonds for the purpose of reducing the yield on the bond. This practice, referred to as "burning the yield," is done after the bond is placed in escrow for an investor who is awaiting repayment.
  6. Marginal Analysis

    An examination of the additional benefits of an activity compared to the additional costs of that activity. Companies use marginal analysis as a decision-making tool to help them maximize their profits. Individuals unconsciously use marginal analysis to make a host of everyday decisions. Marginal analysis is also widely used in microeconomics when analyzing how a complex system is affected by marginal manipulation of its comprising variables.
Trading Center