Bank capital refers to the financial cushion that banks maintain to absorb losses and meet their financial obligations. It represents the difference between a bank’s assets and liabilities and serves as a measure of the bank’s solvency and ability to withstand adverse economic conditions. The capital provides a buffer to protect depositors and other stakeholders in the event of financial losses.

Key components and concepts related to bank capital include:

1. **Regulatory Capital Requirements:**
– Regulatory authorities set minimum capital requirements for banks to ensure their financial stability and protect the interests of depositors and other creditors. These requirements are typically expressed as a percentage of a bank’s risk-weighted assets. The Basel Committee on Banking Supervision provides international standards for bank capital through the Basel Accords.

2. **Common Equity Tier 1 (CET1) Capital:**
– Common Equity Tier 1 capital is considered the highest quality of capital and includes common equity elements such as common shares and retained earnings. It serves as the core measure of a bank’s financial strength and ability to absorb losses.

3. **Additional Tier 1 (AT1) Capital:**
– Additional Tier 1 capital consists of instruments that may include hybrid instruments with both debt and equity features. These instruments have certain loss-absorbing characteristics and provide additional protection to creditors in the event of a bank’s financial distress.

4. **Tier 2 Capital:**
– Tier 2 capital includes subordinated debt and other instruments that contribute to a bank’s capital but are subordinate to Tier 1 capital in terms of loss absorption. Tier 2 capital provides an additional layer of protection beyond Tier 1.

5. **Risk-Weighted Assets:**
– Regulatory capital requirements are often calculated based on the risk-weighted assets of a bank. Different categories of assets are assigned different risk weights, reflecting the perceived level of risk associated with those assets. Higher-risk assets require higher levels of capital.

6. **Leverage Ratio:**
– The leverage ratio is a measure of a bank’s capital adequacy without considering the risk of its assets. It is calculated as the ratio of a bank’s Tier 1 capital to its average total consolidated assets. The leverage ratio provides a simple measure of a bank’s capital relative to its total assets.

7. **Countercyclical Capital Buffer:**
– Some regulatory frameworks incorporate countercyclical capital buffers, allowing regulators to require banks to build up additional capital during periods of economic growth to be drawn down during economic downturns.

8. **Stress Testing:**
– Regulatory authorities conduct stress tests to assess the resilience of banks under adverse economic scenarios. Stress testing evaluates how well banks can withstand severe economic shocks while maintaining adequate capital levels.

9. **Capital Adequacy Ratios:**
– Capital adequacy ratios, such as the Common Equity Tier 1 (CET1) capital ratio, express a bank’s capital as a percentage of its risk-weighted assets. These ratios are used to assess a bank’s compliance with regulatory capital requirements.

Maintaining adequate capital is fundamental to the stability and soundness of banks. It provides a buffer against unexpected losses, enhances depositor confidence, and contributes to the overall resilience of the financial system. Regulatory authorities closely monitor banks’ capital positions to ensure they meet prescribed standards and can withstand financial shocks.