Bank Capital
IntermediateBank capital is the money a bank's owners have invested in it, together with profits it has kept, which acts as a cushion to absorb losses before depositors and other creditors are affected.
A bank's balance sheet follows the same rule as any company's: assets equal liabilities plus equity. A bank's assets are mainly loans and investments. Its liabilities are mainly deposits and borrowing. Its capital is the difference, the owners' equity.
Capital matters because banks are highly leveraged. Most of their funding comes from deposits and borrowing, not from owners. If loans go bad, losses first reduce the bank's capital. As long as capital remains positive, depositors can still be repaid in full.
For example, a bank with 1,000 million of assets, 920 million of deposits and other liabilities, and 80 million of capital can absorb up to 80 million of losses before depositors are at risk.
Because of this, regulators require banks to hold minimum levels of capital relative to the riskiness of their assets, under international standards known as the Basel framework. Higher capital makes banks safer, but it also means owners' money is spread over a larger base, which can reduce returns on equity. Banks and regulators therefore balance safety and profitability.
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