October 16, 2018
New AAF Primer on Bank Capital Requirements
Bank capital requirements have become a universal part of the regulatory regime for the banking industry since the 2008 financial crisis. But what are these requirements, and how do they work? In a new Primer, AAF’s Director of Financial Services Policy Thomas Wade explains the mechanics and nuances of capital rules.
It is attractive to think of capital as liquid cash on hand, but that is an oversimplification. The underlying unburdened assets that make up capital can range widely; as such, the characteristics of that capital (most importantly the liquidity or riskiness) can also range widely. For our purposes we need only focus on Tier 1 (T1) and Tier 2 (T2) capital. T1 capital can be described as the most “perfect” capital; comprising of equity capital and disclosed reserves, it represents the primary funding source of the bank. A bank is under no obligation to return this capital to shareholders – it is genuinely unencumbered. T2 capital by contrast is considered less reliable than T1 and might include undisclosed reserves, revaluation reserves, or hybrid capital instruments.