Capital Instruments under Basel III

Volker Bätz

Capital instruments represent a substantial part of a bank’s balance sheet. They are a source of long-term funding. Capital is used to underpin risk and to absorb losses. Capital requirements, however, are also heavily regulated. The quantity of capital, the type of capital instrument, the currency and the tenor, etc, are more or less influenced by banking regulation. Overlaying banking regulation with asset and liability management (ALM), accounting rules and tax treatment sometimes creates conflicts. There is “no one size fits all” solution for the optimal capital mix for banks, but there are certain aspects to be considered when managing capital as part of the overall asset and liability mix.

In this chapter we show how banking regulations and, in particular, capital requirements work. We describe the various capital instruments that are available for banks by reviewing their characteristics. Finally, ALM aspects in the use of capital instruments in the overall funding mix of a bank are explained.

CAPITAL AS PART OF BANKING REGULATION

Banks are required to maintain capital on their balance sheets to cover unexpected losses. The amount of capital required is regulated and