Regulatory Capital

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Regulatory capital is the minimum amount and quality of capital that banks, insurers and other financial institutions are required by regulators to hold, to absorb losses and protect depositors, policyholders and the financial system.

Financial institutions are highly leveraged, so relatively small losses could wipe out their capital. Regulators require them to maintain capital buffers based on the risks they take.

For banks, regulatory capital requirements are set out in the Basel framework and national rules. They define what counts as capital, such as Common Equity Tier 1, Additional Tier 1 and Tier 2, and set minimum ratios relative to risk-weighted assets, plus buffers and a leverage ratio. For insurers, frameworks such as Solvency II in Europe set capital requirements based on the risks in their insurance and investment activities.

For example, a bank with risk-weighted assets of 100,000,000,000 must hold at least a minimum percentage of that amount in Common Equity Tier 1 capital, plus additional buffers.

Regulatory capital differs from economic capital, which is a firm's own estimate of the capital it needs. Institutions must meet regulatory requirements regardless of their internal estimates, and falling below minimums can trigger restrictions on dividends and bonuses or regulatory intervention.

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