The capital adequacy ratio is the ratio of a bank’s capital expressed as a percentage of its risk-weighted assets.
The regulatory minimum ratio derives from the Basel 2 Accord, implemented in the European Union via the Capital Requirements Directive (CRD) which came into force on 1 January 2008 (Directives 2006/48/EC and 2006/49/EC). The framework consists of three pillars. Pillar 1 sets the minimum capital requirements required to meet credit, market and operational risks. Pillar 2 requires firms and supervisors (in this case the Financial Services Authority—FSA) to take a view on whether a firm should hold additional capital against risks not covered in Pillar 1. Pillar 3 requires firms to publish certain details of their capital and risk management.
Full details of these capital requirements can be found in FSA “GENPRU” and “BIPRU” rulebooks, available via the FSA’s website.
The regulatory minimum capital adequacy ratio under Pillar 1 is 8 per cent. of total capital, of which a minimum of 4 per cent. must be tier 1 capital, which includes ordinary shares and reserves. In practice firms’ regulatory capital may be higher than this, and firms may also decide to hold more capital than the regulatory minimum.
As the FSA made clear in its statement of 19 January, the purpose of the recent bank recapitalisation exercise was to ensure that participating institutions held sufficient capital to ensure a buffer against challenging economic conditions. This did not constitute creating new statutory capital requirements for the UK banking sector.