Definition of total capital ratio
Total capital ratio:
Capital ratios measure the amount of a bank's capital in relation to the amount of risk it is taking. The idea is that all banks must ensure that a reasonable proportion of their risk is covered by permanent capital. Banks must maintain a minimum total capital ratio of 8%. In effect, this means that 8% of the risk-weighted assets must be covered by permanent or near permanent capital. At least half of the regulatory capital must fall into tier 1, which takes into account just the pure equity capital so the tier 1 ratio must be at least 4%. The risk weighting process takes into account the relative risk of various types of lending. For example, a loan to the British Government would be given a risk weighting of 0% (not risky at all) whereas unsecured personal lending would be given a risk weighting of 100%. The higher the capital adequacy ratios a bank has, the greater the level of unexpected losses it can absorb before becoming insolvent - so the less risky it should be.
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