A minimum capital requirement is the smallest amount of capital that a regulated financial firm is permitted to hold. It is set in legislation or by the supervisor, must be met continuously, and falling below it normally leads to supervisory intervention and, ultimately, loss of the licence. The requirement exists so that owners, rather than depositors, policyholders or customers, absorb losses, and so that a firm has resources to keep operating or to be wound down in an orderly way. A closely related term with its own short entry is capital requirement.
The term is used in three ways. For banks it means the risk-based ratios of the Basel framework. For European insurers it is a defined term, the Minimum Capital Requirement of Solvency II, which sits below the higher Solvency Capital Requirement. For payment firms, brokers and other licensed businesses it often means a fixed initial capital amount that must be in place before authorisation, sometimes supplemented by a formula.
Banks under the Basel framework
Bank minimums are expressed as ratios of capital to risk-weighted assets, which scale each exposure according to its riskiness. Under Basel III a bank must hold at least:
- 4.5 per cent in Common Equity Tier 1. Common Equity Tier 1 consists of ordinary shares and retained earnings after regulatory deductions.
- 6 per cent in Tier 1 capital. This adds Additional Tier 1 instruments, which are perpetual and can be written down or converted.
- 8 per cent in total capital. This adds Tier 2 capital, mainly long-dated subordinated debt, and is measured by the total capital ratio.
These figures are the Pillar 1 capital requirement. Alongside them sits a non-risk-based leverage ratio of 3 per cent of Tier 1 capital to total exposure, intended as a backstop in case risk weights are too low.
In practice a bank's effective minimum is higher. Supervisors add a bank-specific Pillar 2 capital requirement for risks that the standard formulas do not capture. On top of the minimums are buffers, including the capital conservation buffer of 2.5 per cent and surcharges for systemically important banks. Buffers are not strictly minimums, since a bank may dip into them, but doing so restricts dividends and bonuses, so banks treat the combined figure as their working floor.
Insurers under Solvency II
Solvency II, the European Union's prudential regime for insurers, in force since 2016, uses two capital levels. The Solvency Capital Requirement is the target level, calibrated so that an insurer can withstand a loss expected only once in two hundred years over a twelve-month horizon. The Minimum Capital Requirement (MCR) is a lower threshold calibrated to a confidence level of 85 per cent over the same horizon.
The MCR is calculated with a simple linear formula based on technical provisions, premiums and capital at risk, constrained to lie between 25 and 45 per cent of the Solvency Capital Requirement, and subject to an absolute floor in euros that depends on the type of insurer. It must be covered by the highest-quality own funds. The two levels form a ladder of intervention: breaching the higher requirement obliges the insurer to submit a recovery plan, while breaching the MCR and failing to restore it within a short period leads to withdrawal of authorisation. Insurers assess their own position against both in the Own Risk and Solvency Assessment.
Payment, e-money and investment firms
Non-bank firms usually face a fixed amount of initial capital plus an ongoing requirement. Under European Union payment services law, a payment institution must hold initial capital of 20,000 euros if it provides only money remittance, 50,000 euros for payment initiation services and 125,000 euros for most other payment services, and an electronic money institution must hold 350,000 euros. Ongoing own funds must not fall below the higher of the initial figure and an amount calculated from payment volumes, fixed overheads or outstanding e-money. Similar tiered structures apply to investment firms and, in the United States, to money transmitters, where states set net worth and surety bond requirements.
What happens when the minimum is breached
Supervisors seek to act before the minimum is reached. Banks must maintain recovery plans and report early-warning indicators, and a bank approaching its requirement can expect restrictions on distributions, demands to raise capital or reduce risk, and closer monitoring. A bank that breaches the minimum and cannot restore it may be judged failing or likely to fail, which is the trigger for resolution or insolvency. For smaller licensed firms, the regulator may suspend or cancel the authorisation.
Limitations
Minimum requirements depend on how capital and risk are measured. Before the 2007 to 2009 crisis many banks reported ratios comfortably above the minimum while holding little loss-absorbing equity, because the definition of capital was loose and risk weights understated exposure. Later reforms tightened both. Capital requirements also do not address liquidity: a firm with ample capital can still fail if it cannot meet withdrawals, which is why separate liquidity standards exist.