Capital ratio

In an attempt to prevent organisations such as banks from going bust too easily, regulators impose minimum capital requirements on them...

In an attempt to prevent organisations such as banks from going bust too easily, regulators impose minimum capital requirements on them: a bank should ensure that its own funds (capital that it can count as its own) as a proportion of "risk-weighted assets" (money it is owed by other people, allowing for non-payment risk) exceeds a regulatory target. A regulator can vary this target the riskier the bank, the higher the target.

A bank's "own funds" can be subdivided into different tiers, with "tier one" representing capital of the highest quality typically funds raised from issuing shares, combined with past profits. So suppose a bank issued $100 of shares ten years ago and has made $100 of profit over the last decade, its "own funds" would be $200.

Now assume that it is owed $1,600 as a result of lending to third parties and the regulator has set a tier one target of 10%. Well, 200/1,600 is 12.5%, which beats the target so all is well (hopefully).

Most Popular

Fan heater vs oil heater – which is cheaper?
Personal finance

Fan heater vs oil heater – which is cheaper?

Sales of portable heaters have soared, as households look to cut their energy costs. But which is better: a fan heater or an oil heater? We put them t…
21 Nov 2022
Stock market crash? This time it’s (slightly) different
Stockmarkets

Stock market crash? This time it’s (slightly) different

The bears expecting a stock market crash have got it wrong, says Max King.
30 Nov 2022
Is it cheaper to leave the heating on low all day?
Personal finance

Is it cheaper to leave the heating on low all day?

The weather is getting colder and energy bills are rising, but is it really cheaper to leave the heating on low all day or should you only turn it on …
1 Dec 2022