Capital adequacy

With the recent credit crunch around the world and there being a big spotlight on the banks, the financial instruments they used, and whether they were adequately protected, there has been a lot of focus on capital adequacy.

This refers to the requirement for a bank to be able to protect those who have deposits with the bank from losses, and also enough to enable their assets to grow.

In other words it is a measure of how leveraged the bank is, and how much actual money it has (liquidity) to cover debts and so on. The higher the leverage, the riskier the balance sheet and in theory the more closely regulated the bank should be.

Around the credit crunch time the capital-to-assets ratio for many banks was dangerously low meaning that there was real risk of collapse without government bailouts; typically an average of around 8% being maintained was the risk-based capital standard.

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