Capital (General)

What is capital in banking

In banking, capital is the money a bank has that acts as a cushion against losses. It’s not the same as the money a bank holds for day-to-day operations or customer deposits. Instead, capital is what the bank’s owners have invested, plus any profits the bank has kept over time. It’s there to protect the bank, its customers, and the financial system if things go wrong.

Think of capital as a safety net. If a bank makes bad loans or faces unexpected losses, capital is what absorbs those hits. Without enough capital, a bank could fail—and that could hurt depositors, investors, and even the broader economy.

Why capital matters

Banks take on risk every day. They lend money, invest in markets, and handle complex financial products. These activities can be profitable, but they also carry the risk of loss. Capital helps ensure that a bank can keep operating even when some of those risks don’t pay off.

Regulators like the Office of the Superintendent of Financial Institutions (OSFI) in Canada require banks to hold a certain amount of capital. These rules are part of what’s called capital adequacy requirements. They make sure banks are strong enough to handle tough times—like a recession or a financial crisis—without needing a government bailout.

Types of capital

Bank capital comes in different layers, often called the capital stack:

• Common Equity Tier 1 (CET1): This is the highest-quality capital. It includes common shares and retained earnings. It’s the first line of defense against losses.
• Additional Tier 1 (AT1): This includes instruments like preferred shares that can be converted into equity or written off if needed.
• Tier 2 Capital: This includes things like subordinated debt, which helps cover losses if the bank fails.

Each layer plays a role in protecting the bank and its customers.

In summary

Capital is essential to a bank’s health. It helps absorb losses, protects depositors, and supports trust in the financial system. By holding enough capital, banks can continue to lend and operate safely—even in uncertain times. That’s why capital is a cornerstone of banking regulation and financial stability.