Bank Capital

What is bank capital?

Bank capital is a bank’s net worth or equity — the difference between its assets and liabilities. It represents the funds available to absorb losses and protect depositors and creditors if the bank faces financial distress or liquidation.

Why it matters

• Bank capital supports ongoing operations when losses occur, reducing the risk of insolvency.
• Regulators monitor capital to ensure financial stability and protect the broader economy.
• Investors and creditors use capital levels as an indicator of a bank’s financial strength.

How bank capital works

Banks hold assets such as cash, government securities, and loans; liabilities include customer deposits, debt, and loan-loss reserves. Capital sits between these groups as the loss-absorbing layer. Regulators define specific measures of “regulatory capital” and set minimum ratios that compare capital to risk-weighted assets.

The Basel Committee on Banking Supervision (Basel I/II/III) provides internationally recognized frameworks that most jurisdictions use to set capital standards. Basel III, the most recent major framework, refines capital definitions and minimum requirements to improve banking-system resilience.

Regulatory capital classifications (Basel III)

Regulatory capital is divided into tiers based on loss-absorbing capacity and permanence.

Common Equity Tier 1 (CET1)

• Highest-quality capital.
• Includes common shares (book value), paid-in capital, and retained earnings.
• Less goodwill and other intangible assets.
• No maturity and highest subordination — first to absorb losses while the bank remains a going concern.

Tier 1 Capital

• Consists of CET1 plus additional instruments that are effectively permanent (no fixed maturity), subordinated to most other debt, and allow the bank to suspend dividends or coupons if needed.
• Represents the core measure of a bank’s ability to absorb losses without shutting down operations.
• Basel III minimum Tier 1 capital ratio: 8.5% (Tier 1 capital divided by risk-weighted assets).

Example: If a bank has Tier 1 capital of $176.263 billion and risk-weighted assets of $1.243 trillion, its Tier 1 capital ratio is 176.263 / 1,243 = 14.18%, exceeding the 8.5% minimum.

Tier 2 Capital

• Supplementary capital that is less loss-absorbing than Tier 1.
• Includes subordinated term debt, certain hybrid instruments, revaluation reserves, general loan-loss reserves, and undisclosed reserves.
• More difficult to liquidate and measure precisely; used to complement Tier 1 in the total regulatory capital base.
• Basel III sets a minimum total capital ratio (Tier 1 + Tier 2) of 10.5%, but does not mandate a specific Tier 2 minimum.

Book value of shareholders’ equity

Bank capital is often approximated by the book value of shareholders’ equity on the balance sheet, calculated as assets minus liabilities. Typical components:
– Common and preferred equity
– Paid-in capital
– Retained earnings
– Accumulated other comprehensive income

Because banks frequently revalue financial assets, shareholders’ equity tends to be a reasonable proxy for capital in practice.

Key takeaways

• Bank capital equals assets minus liabilities and serves as the primary buffer against losses.
• Regulators require minimum capital levels (Basel III standards) to protect depositors and the financial system.
• CET1 is the highest-quality capital; Tier 1 is the core capital measure; Tier 2 is supplementary.
• Capital ratios (capital divided by risk-weighted assets) are the standard way to assess a bank’s capital adequacy.