An Introduction to Banking, 2nd Edition

Chapter 15BANK REGULATORY CAPITAL, BASEL RULES AND ICAAP

A bank's strategy is closely linked to its capital position. That said, a bank's capital position also drives its strategy. Like all commercial enterprises, the return shareholders receive for their investment in a bank or financial holding company is of critical importance when considering the value generated. Furthermore, the regulators and society in general require banks to be well capitalised to reduce friction to the financial system. Well‐regulated and strongly capitalised banks are fundamental to a robust financial system.

Bank capital is a concept that is central to the understanding, and management, of a bank's business strategy and the risk exposure associated with that strategy. In the business media, it is often suggested that capital is the most important aspect of bank risk management, but although such a view is not wholly correct (liquidity and funding are as important certainly, if not more so), it is indeed the case that effective capital management is essential if a bank is to continue to deliver shareholder returns through the economic cycle. Put simply, understanding capital is key to understanding what banks do, the risks they take, and how best these risks should be managed.

Often capital is spoken of as being “held” or “put aside” by a bank in order to support lending operations, as if it was some kind of asset. This is an unfortunate turn of phrase. Far from being an asset, capital is a liability, ...