This lesson focuses on the assessment of a bank’s capital adequacy, a key indicator of its financial strength .

8.1 The Purpose of Bank Capital
Bank capital is a buffer to absorb losses and protect depositors. It is the difference between a bank’s assets and liabilities . The key metrics are the capital ratios defined by the Basel framework.

8.2 Types of Capital

  • Tier 1 Capital: Core capital, including equity and disclosed reserves. This is the highest quality capital .

  • Common Equity Tier 1 (CET1): The highest quality of Tier 1 capital .

  • Additional Tier 1: Includes instruments like perpetual bonds that can be converted to equity .

  • Tier 2 Capital: Lower-quality capital, such as subordinated debt .

8.3 Risk-Weighted Assets (RWA)
Capital adequacy ratios are measured against risk-weighted assets (RWA). Different assets have different risk weights. For example, cash and government bonds have lower risk weights than corporate loans .

8.4 The Basel Framework
The Basel Accords are the primary international regulatory framework for banks. Basel III has significantly tightened capital and liquidity requirements

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