Capital requirement (also known as regulatory capital or capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. Capital is supposed to protect a bank from all sorts of uninsured and unsecured risks apt to turn into losses.
The principal functions of capital include:
- To counter any systemic fragilities in the financial system and to ensure that banks have sufficient core capital to contain the menace of unexpected losses.
- To ensure that the bank operates at a size which is more conducive to economies of scale in order to retain qualified staff, well functioning IT infrastructure and a reasonable level of branch network etc.
- To ensure that financial stake of sponsors/owners in the bank is significantly large in order to encourage prudent behavior.
- To protect depositors and other claim holders.
- To provide enough confidence to external investors and rating agencies on the financial heath and viability of the institution.
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