Learning Objectives:

• Define regulatory capital and its components.

• Understand capital adequacy ratios and their calculation.

• Explain the Basel framework for capital adequacy.

5.1 The Purpose of Bank Capital

Bank capital serves as a buffer to absorb losses, protecting depositors and the financial system. The University of Aberdeen course requires students to “understand theory and practice of international banking” and to “explain how risks can be managed” . The Jazan University course identifies “capital adequacy” as a core banking risk . The University of Aberdeen course also covers “the nature of risks faced by banks” and “how risks can be managed” .

5.2 Types of Regulatory Capital

Regulatory capital is classified into tiers based on its quality and ability to absorb losses:

• Tier 1 Capital: Core capital, including equity and disclosed reserves. This is the highest quality capital. It includes Common Equity Tier 1 (CET1) (common shares and retained earnings) and Additional Tier 1 (instruments that can be converted to equity).

• Tier 2 Capital: Lower-quality capital, such as subordinated debt and loan-loss reserves.

• Total Capital: Tier 1 + Tier 2.

The Marwadi University course covers “Capital framework of banks – Tier I and Tier II capital for Indian banks – Risk adjusted assets” . The Siena University course covers “equity book value vs. regulated capital” as a core topic .

5.3 Capital Adequacy Ratios

Capital adequacy is measured by ratios that compare capital to risk-weighted assets:

• CET1 Ratio: CET1 capital divided by Risk-Weighted Assets (RWA).

• Tier 1 Ratio: Tier 1 capital divided by RWA.

• Total Capital Ratio: Total capital divided by RWA.

The Siena University course covers “capital planning process” and “bank capital planning” as core topics . Basel III introduced a minimum CET1 ratio of 4.5%, with additional capital conservation and countercyclical buffers. The Basel framework is a core component of the University of Aberdeen course’s emphasis on risk management .