Bank capital requirements force banks to fund a portion of their assets with shareholder equity and other loss-absorbing instruments rather than depositor money or short-term debt. The logic is simple: when loans go bad, capital absorbs the loss before depositors or the state must. Higher capital ratios reduce the probability of insolvency, dampen credit booms, and limit the externalities of bank failure on the wider economy.
The modern framework is set by the Basel Accords, drafted by the Basel Committee on Banking Supervision (BCBS), hosted at the Bank for International Settlements in Basel, Switzerland. Basel I (1988) introduced an 8% minimum ratio of capital to risk-weighted assets (RWA). Basel II (2004) refined risk weighting and added supervisory and disclosure pillars. After the 2007–2008 financial crisis, Basel III (published 2010, phased in over the 2010s and 2020s) raised both the quantity and quality of capital.
Under Basel III, banks must hold:
- Common Equity Tier 1 (CET1) of at least 4.5% of RWA — the highest-quality capital, essentially common shares and retained earnings.
- Tier 1 capital of at least 6% of RWA.
- Total capital of at least 8% of RWA.
- A capital conservation buffer of 2.5% CET1 on top, plus a discretionary countercyclical buffer of 0–2.5%.
- A leverage ratio (non-risk-weighted) of at least 3%.
- Surcharges for global systemically important banks (G-SIBs) identified annually by the Financial Stability Board.
Basel standards are not self-executing; jurisdictions implement them through domestic law — the EU's Capital Requirements Regulation and Directive (CRR/CRD), the US Dodd-Frank Act and Federal Reserve rules, and the UK's PRA rulebook. The final Basel III package, often called "Basel III endgame" or "Basel 3.1," tightens internal-model use and introduces an output floor; implementation timelines in the EU, UK, and US have slipped into 2025–2028.
Critics argue high requirements constrain lending; defenders, including economists Anat Admati and Martin Hellwig, contend banks remain undercapitalized relative to social risk.
Example
In March 2023, after the collapse of Silicon Valley Bank and Signature Bank, US regulators proposed a "Basel III endgame" rule requiring large American banks to hold roughly 16% more CET1 capital against risk-weighted assets.
Frequently asked questions
Because banking is cross-border and capital can flow to lax jurisdictions, the Basel Committee coordinates minimum standards to prevent regulatory arbitrage. National regulators may still impose stricter rules.
Keep learning