What Is a Capital Requirement?

What Is a Capital Requirement?

By Charles Joseph | Editor, Financial Affairs
Reviewed by Corey Michael | Senior Financial Analyst

A capital requirement is the standard amount of capital a bank or other financial institution must hold, according to its financial regulator. This is defined as a percentage of a bank’s risk-weighted credit exposures. This rule is put in place to ensure that the institutions can absorb a reasonable amount of loss and are compliant with their statutory Capital requirements. This protects depositors and promotes the stability and efficiency of financial systems around the world.

Related Questions

1. What is the purpose of capital requirements?

Capital requirements are set up to ensure that banks and financial institutions can cover potential losses. They are made to encourage banks to manage their risks wisely, preventing them from taking excessive risks. By holding a standard amount of capital, this minimizes the chances of them going bankrupt and safeguards the financial system and depositors.

2. How are capital requirements calculated?

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Capital requirements are typically calculated as a percentage of a bank’s risk-weighted assets. These assets are a bank’s balance sheet assets, off-balance-sheet exposures, and some equity investments, with each type of asset assigned a risk weight based on the chance of default. The higher the risk, the higher the capital requirement.

3. What happens if a bank fails to meet capital requirements?

If a bank fails to meet the capital requirement set by its regulator, it can face severe penalties. These penalties may include limitations on making investments, payments, or even actions such as replacing management or a forced merger. It may also be prohibited from giving dividends to its shareholders.

4. Are capital requirements the same in every country?

No, capital requirements differ from country to country. However, there is an international standard set out in the Basel III agreement managed by the Bank for International Settlements. Countries typically adjust these standards to their needs, but they must ensure their regulations are equivalent to that standard.

5. What is the current minimum capital requirement?

The exact minimum capital requirement varies from country to country. However, according to Basel III standards, banks are required to hold the minimum capital of 8% of risk-weighted assets.