Capital adequacy

Central banks impose capital adequacy ratios (also known as solvency ratios) that set the amount of its own money a bank needs to have relative to its total loan portfolio.

A bank needs to have enough money on hand to cover any losses it might make if any of the groups or individuals it has lent money defaults on their loans. If it does not, it may find itself unable to cover what it owes to its depositors, and hence become insolvent.

Central banks do not allow commercial banks to decide for themselves how much to keep to cover the risk. Instead, they impose capital adequacy ratios (also known as solvency ratios) that set the amount of its own money a bank needs relative to its total loan portfolio.

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