Regulatory Capital Requirements

Capital management is mainly concerned with managing available capital. Required capital is, among other things, a function of the business a financial institution conducts. Managing required capital is definitely a part of capital management, but it is much slower to take effect because one effectively has to change the way business is conducted. Although managing required capital is only a part of capital management, it is a crucial constraint to take into account in any capital management decision. On top of that, required capital should be under control and it is therefore, imperative to understand the regulatory capital requirement framework. Hence, this chapter focuses on capital requirements for banks and insurance companies. The main capital requirement for banks relates to the BIS ratio. The requirement is that total available capital divided by risk-weighted assets has to exceed 8%. To be able to calculate the minimum required capital one has to understand the concept of risk-weighted assets (RWAs). RWAs measure the riskiness of the assets that a bank. Thus, riskier assets leads to higher RWAs, and hence higher the required capital.