Capital
Put simply, capital is the difference between the assets of the bank (such as loans and securities) and the liabilities of the bank (such as deposits and other borrowings). Bank regulatory capital is the minimum amount of capital that a bank must maintain—generally set by regulation—to absorb losses and protect depositors and the broader financial system from bank failures. Bank regulatory capital primarily consists of common shareholders’ equity (referred to by regulators as common equity tier 1, or CET1 capital) but can also include retained earnings and certain types of preferred stock.
Increasing bank regulatory capital requirements can lower systemic risk, but it also reduces banks’ capacity to make loans, support capital markets or engage in other economically productive activities and/or increases the costs of engaging in these activities. In other words, the supply of bank credit for businesses and households falls. Academic studies have attempted to estimate the optimal setting for bank regulatory capital requirements that best balances the tradeoff between these costs and benefits. U.S. banks, in aggregate, hold regulatory capital above the optimal range estimated by many of the studies. Learn more.
Liquidity
The term “liquidity” has two related but distinct meanings in finance. An asset is liquid if it can be bought or sold quickly without significantly moving the price of the asset. An institution is liquid if it can meet its scheduled payments or demands for funds without incurring high costs. Bank liquidity refers to the latter meaning but also depends on the former. A bank is liquid if it can repay borrowers when due, meet deposit withdrawals and satisfy draws on existing lines of credit without paying inordinately in funding markets or selling assets at fire-sale prices. Moreover, because banks provide funding to each other, liquidity problems at one bank can quickly spill over to other banks.
7 Key Takeaways from the House Financial Services Subcommittee Hearing on Basel III Endgame
To see how these concepts play out in current policy debates, watch our recap of the 2024 House Financial Services Committee hearing Rules Without Analysis: Federal Banking Proposals Under the Biden Administration where BPI President and CEO Greg Baer testified on the real-world impact of proposed capital rules.
