Chapter 12. Capital Adequacy

As we learned in the previous chapter, banking is a specifically risky industry and the safety of the clients' money is a top priority. In order to ensure that banks meet this primary objective, the industry is under strict regulation. It has always been a very important task for supervisors to build rules to avoid the collapsing of banks and to protect clients' wealth. Capital adequacy or capital requirement is one of, if not, the most, important regulatory tool to serve this goal. Given the high leverage in the financial sector, banks and other financial institutions are not allowed to freely use all their assets. These firms need to hold enough capital to ensure safe operation and solvency even if things turn bad.

Different countries have different banking supervisory bodies (financial watchdog, central bank, and so on) and regulation standards. However, as the banking system became more and more globalized, a common worldwide standard became necessary. In...