Risk Based Capital

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RISK BASED CAPITAL
Capital requirement
The standardized requirements in place for banks and other depository institutions, which determines how much capital is required to be held for a certain level of assets through regulatory agencies such as the Bank for International Settlements, Federal Deposit Insurance Corporation or Federal Reserve Board. These requirements are put into place to ensure that these institutions are not participating or holding investments that increase the risk of default and that they have enough capital to sustain operating losses while still honoring withdrawals. Also known as "regulatory capital".

The Basel Accords, published by the Basel Committee on Banking Supervision housed at the Bank for International Settlements, sets a framework on how banks and depository institutions must calculate their capital. In 1988, the Committee decided to introduce a capital measurement system commonly referred to as Basel I. This framework has been replaced by a significantly more complex capital adequacy framework commonly known as Basel II. After 2012 it will be replaced by Basel III [2]. Another term commonly used in the context of the frameworks is Economic Capital, which can be thought of as the capital level bank shareholders would choose in absence of capital regulation. For a detailed study on the differences between these two definitions of capital, refer to [3].
The capital ratio is the percentage of a bank's capital to its risk-weighted assets. Weights are defined by risk-sensitivity ratios whose calculation is dictated under the relevant Accord. Basel II requires that the total capital ratio must be no lower than 8%.
Each national regulator normally has a very slightly different way of calculating bank capital, designed to meet the common requirements within their individual national legal framework.
Most developed countries implement…...

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