Capital
What is it?
Before looking at what a bank's capital is, it's worth looking at what it does.
A bank's capital reserves perform an important function: they enable the bank to continue functioning even when it isn't making profits. In the case of a retail bank, they therefore help reassure depositors that they'll get their money back even when the bank is going through a hard time. And a result, they help preserve confidence in the bank, and in the banking system as a whole.
Not everything counts as capital, however. For example, a bank that raises money through issuing bonds will have to repay the loan, and therefore can't use that loan as a buffer to absorb a loss. That loan isn't capital.
There are only a few things that banks can count as capital for regulatory purposes. And these are divided into three categories, or tiers, known simply as tier one, tier two and tier three. Only tier one and tier two capital typically counts.
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What's it got to do with the financial crisis?
As a result of the credit crunch and huge writedowns on asset backed securities related to sub-prime mortgages and other bad debts, banks have seen the value of their capital eroded and the value of their debts increase.
The amount of capital they're obliged to hold as a buffer against losses under Basel II - and their capital adequacy - has become a hot topic.
Last updated on 26 September 2008.
