Risk-Based Capital Requirement

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DEFINITION

A rule that establishes minimum required liquid reserves for financial institutions. Risk-based capital requirements exist to protect the firms, their investors and customers and the economy as a whole. Placement of risk-based capital requirements ensure that each financial institution has enough capital to sustain operating losses while maintaining a safe and efficient market. In June 2011, the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System and the FDIC adopted a rule that enforces a permanent floor for risk-based capital requirements. The rule also provides some flexibility in risk calculation for certain low-risk assets.


Also known as regulatory capital.



INVESTOPEDIA EXPLAINS

The Collins Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as "Dodd-Frank") imposes minimum risk-based capital requirements for insured depository institutions, depository institution holding firms and nonbank financial companies that are supervised by the Federal Reserve. Under the rules, each bank is required to have a total risk-based capital ratio of 8% and a tier 1 risk-based capital ratio of 4%.

The Basel Committee on Banking Supervision, which operates through the Bank for International Settlements, publishes the Basel Accords – the structure by which banks and depository institutions calculate capital. Basel I was introduced in 1988, followed by Basel II in 2004. Basel III was developed in response to deficits in financial regulation that appeared in the late 2000s financial crisis.


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