Capital Requirements Definition

What are capital requirements?

Capital requirements are the guidelines that banks and other financial institutions must follow in order to maintain a certain level of financial stability. The rules are set by various regulatory bodies, such as the Basel Committee on Banking Supervision, and they dictate how much money these institutions must keep in reserve in order to protect themselves against potential losses.

Why are capital requirements important?

Capital requirements are important because they help ensure that banks and other financial institutions are able to weather economic downturns without collapsing and needing a government bailout. By requiring these institutions to keep a certain amount of money in reserve, it reduces the likelihood that they will take on too much risk and experience severe losses that could jeopardize their solvency.

What are the different types of capital requirements?

There are two main types of capital requirements: tier 1 capital and tier 2 capital. Tier 1 capital is the core equity that a financial institution must maintain, and it consists of items such as common stock and retained earnings. Tier 2 capital is supplementary equity that can be used to absorb losses in times of distress, and it includes items such as subordinated debt and preference shares.