Glossary term
Regulatory Capital
Subject: Risk Management, Prudential and Capital Risk
Also known as: Capital requirement
Regulatory capital is the amount and type of capital that supervisors require a financial firm to hold against its risks, defined by their rules about what counts and how much is needed.
Explanation
A firm's own view of how much capital it needs can differ from the regulator's. Regulatory capital is the supervisor's version. Rules first say what qualifies: ordinary shares and retained earnings rank highest because they absorb losses while the firm keeps trading, while some debt instruments rank lower. Rules then set how much is required, usually as a ratio to risk-weighted assets or to total exposure. Under Basel III, banks hold Tier 1 and Tier 2 capital plus buffers on top of the minimum. Insurers and other regulated sectors have their own regimes. Firms report their position regularly and face restrictions if it falls short. Dividend, buyback and lending decisions are checked against this figure, because falling short brings restrictions.
Example
A bank has equity and retained profit of 900, plus qualifying subordinated debt of 200. After deducting some intangible assets, the supervisor accepts 1,000 as regulatory capital. Risk-weighted assets are 8,000, so the capital ratio is 12.5%, above the minimum plus buffers, and the bank may keep paying dividends.
Not to be confused with
- Economic capital
- Economic capital is the firm's own estimate of capital needed for its risks. Regulatory capital follows the supervisor's definitions and minimums.