A02 · TOPIC · capital-and-liquidityGRA dossier · service level R0
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Topic dossier · Banking Nexus

Capital and liquidity

Capital absorbs losses and liquidity keeps a bank paying its obligations as they fall due. A bank fails when either runs out, and a liquidity run can bring down a bank whose capital looked adequate. This page explains how capital and liquidity buffers are defined under Basel III, how they behave under stress, how funding can unravel quickly, and how supervisors and central banks use stress tests and facilities to judge whether buffers are enough.

01In brief

The short answer.

Bank capital and liquidity are the two buffers that keep a bank alive: capital absorbs losses and liquidity keeps it paying obligations as they fall due. A bank fails when either runs out, and a liquidity run can bring down a bank whose capital looked adequate. Basel III defines both, and stress tests probe them.

02Spatial finance

A loan book under scenario families.

How physical and transition risk could reach a loan book under different scenarios. Illustrative design values.

A loan book across Europe under physical and transition risk.Design values; NGFS scenario names are labels only, not stress test results.
03The question

Capital and liquidity: how the risk develops.

Buffers, funding and stress. The dossier below sets out how the risk develops, what is measured, where the data come from, how it is modelled and who decides.

Mechanism

Losses deplete capital

Credit, market and operational losses reduce common equity. As capital ratios approach buffer levels, restrictions on distributions apply and banks may cut lending to rebuild ratios, passing the stress on to borrowers.

Mechanism

Funding can run quickly

Uninsured deposits, wholesale funding and secured financing can be withdrawn within days, faster still with digital banking and rapid information spread. Concentrated deposit bases and maturity mismatch make a run self-reinforcing.

Mechanism

Liquidity stress becomes solvency stress

To meet outflows a bank sells assets. Fire sales depress prices, unrealised losses on securities become realised and haircuts widen, so a liquidity problem turns into a capital problem for the seller and for others holding similar assets.

Mechanism

Buffers have to be usable

Buffers exist to be drawn down in stress, yet banks may hesitate to use them for fear of market stigma. Central bank facilities and pre-positioned collateral decide whether liquidity support can arrive in time.

04Key terms

Terms used on this page.

Each term as this page uses it. Where a standard-setting body defines the term, the wording follows that body.

TermDefinition
Leverage ratioTier 1 capital divided by total exposure, a backstop that ignores risk weights.
Net stable funding ratioAvailable stable funding relative to required stable funding over one year.
Capital bufferCapital held above minimum requirements that can be drawn down in stress without breaching them.
05Indicators

What is measured, and how well.

Each indicator carries its unit, its cadence, the kind of source behind it and the evidence label a value would carry. No values are shown: a programme supplies them under its own authority.

IndicatorUnitCadenceSource typeLabel
Common equity tier 1 ratiopercent of risk-weighted assetsquarterlySupervisory returns, Pillar 3 disclosuresOFFICIAL
Leverage ratiopercent of total exposure measurequarterlySupervisory returnsOFFICIAL
Liquidity coverage ratiopercent of net cash outflows over a thirty-day stressmonthlySupervisory liquidity returnsOFFICIAL
Net stable funding ratiopercent of required stable fundingquarterlySupervisory returnsOFFICIAL
Uninsured deposit sharepercent of total depositsquarterlyRegulatory filingsREPORTED
Stressed capital depletionpercentage points of CET1 ratioannualSupervisory stress testsMODELLED
Unrealised losses on securitiespercent of CET1 capitalquarterlyFinancial statementsREPORTED
Asset encumbrance ratiopercent of total assetsquarterlyAsset encumbrance reportingOFFICIAL
06Canvas

From sources to decisions.

The topic as a computational graph: named sources feed the methods, an evidence review gates the outputs, and the decisions stay with the authorities that hold them.

Pipeline canvas · Capital and liquidity as a run graphDesign, not a record
Capital and liquidity: capital adequacy assessmentExposures are aggregated and weighted; the capital stack and buffers are set against requirements; stress scenarios test the ratio; the internal assessment (ICAAP or ORSA) goes to the board and the supervisor. Design of the process, not a record of a run.

Fig. 02Nodes carry their type, two metric rows and a state; connectors show what feeds what; dashed frames name the owners; the timeline is the cadence. Design of the pipeline, not a record of a run.

07Sources

Where the evidence comes from.

Named public datasets and institutional records, each with its licence class. Sources by agreement are used only under their terms and never republished.

SourceWhat it givesLicence class
BIS Basel III monitoring reportsAggregate capital, leverage and liquidity positions of internationally active banksFree, BIS terms of use
Federal Reserve supervisory stress test resultsScenario design, projected losses and post-stress capital for large US banksPublic domain
Bank of England stress testing resultsScenario design and outcomes of concurrent and exploratory stress tests for major UK banksFree, Bank of England terms of use
EBA EU-wide stress testBank-level stressed capital projections under a common methodologyFree, attribution
ECB Supervisory Banking StatisticsCapital adequacy, leverage and liquidity aggregates for significant institutionsFree, attribution
IMF Financial Soundness IndicatorsRegulatory capital and liquid asset ratios across countriesFree, IMF terms of use
Pillar 3 disclosuresBank-published capital composition, risk-weighted assets, LCR and NSFRPublic, bank terms
08Decisions

Who decides, and what the evidence serves.

Banking Nexus prepares evidence. The decisions below are taken by the authorities named, under their own rules, and never by the platform.

Who decidesThe questionEvidence this page serves
Bank board and asset liability committeeWhat capital target and management buffer to hold, and how to structure fundingCapital and liquidity projections under internal and supervisory scenarios
Prudential supervisor through SREP or CCARWhether Pillar 2 requirements, guidance or a stress capital buffer should changeStress test results, ICAAP and ILAAP reviews, peer comparison
Macroprudential authorityWhether to raise or release the countercyclical capital bufferCredit-to-GDP gaps, system-wide stress results, lending conditions
Central bankWhich collateral and terms to accept in standing and lender-of-last-resort facilitiesPre-positioned collateral, encumbrance and run scenarios

Outputs this topic produces

  • Explainers on the Basel III capital stack, buffers and liquidity ratios
  • Comparative notes on supervisory stress test designs and their assumptions
  • Liquidity run and fire-sale scenario narratives for training and exercises
  • Research on the usability of buffers and on central bank liquidity facilities
09Core questions

Shared questions the industry asks.

  1. 01

    How much loss can buffers absorb?

    How capital and provisions behave under severe but plausible scenarios.

  2. 02

    How stable is funding?

    Which deposits and market funding are likely to run in stress, and how fast.

  3. 03

    How do liquidity and solvency interact?

    How fire sales, margin calls and funding loss turn liquidity stress into losses.

  4. 04

    How do new channels change runs?

    The effect of digital banking and social media on the speed of deposit outflows.

10Mechanisms

How the risk arises and transmits.

Leverage means that a small fall in asset values can erase a large share of capital. Capital requirements set minimum buffers, and additional buffers are designed to be usable in stress, though banks may be reluctant to draw on them.

Maturity transformation creates liquidity risk. Banks fund long-term loans with deposits and short-term borrowing that can be withdrawn. Liquid asset buffers and stable funding requirements aim to cover outflows for a period of stress.

Runs are coordination problems. Depositors who fear others will withdraw have reason to withdraw first. Uninsured deposits, concentrated depositor bases and fast digital channels can make outflows sudden.

Liquidity and solvency feed each other. Selling assets in a hurry realizes losses; losses reduce confidence and funding. Central bank facilities exist to break this loop, under their own terms.

Interest rate changes affect both. Rising rates reduce the value of fixed-rate assets and can prompt deposit outflows to higher-yielding alternatives.

11Methods and limits

How evidence is gathered, and where it stops.

Method or dataWhat it showsIts limit
Stress testingCapital and liquidity under scenariosScenarios may miss the shock that occurs
Behavioural funding modelsExpected deposit outflowsCalibrated on past behaviour
Regulatory reportingBuffers and funding profilesPoint-in-time; aggregated for research
Market indicatorsFunding costs and confidenceNoisy and reflexive
12Methods

How it is studied, and what the methods cannot say.

  1. Financial and risk engineeringExpected credit loss modelling · Counterparty exposure and valuation adjustmentsApplied here
  2. Financial economics and macro-financeMacro-financial stress scenarios · Credit cycle and buffer calibrationApplied here
  3. Probability and statisticsEstimating default and loss parameters · Operational loss modellingApplied here
  4. Network science and contagionInterbank and counterparty contagion · Overlapping portfolios and fire salesApplied here
13Questions

Questions and answers.

Why do banks need both capital and liquidity?
Capital absorbs losses so a bank stays solvent; liquidity lets it meet payments as they fall due. A solvent bank can fail if it cannot fund itself, and ample liquidity cannot save a bank whose losses exceed its capital.
What is the difference between a requirement and a buffer?
Minimum requirements must be met at all times. Buffers sit above them and can be drawn down in stress, with automatic limits on distributions such as dividends and bonuses as the buffer is used.
What does a supervisory stress test show?
How a bank's capital would evolve under a severe but plausible scenario set by the supervisor. It tests resilience to that scenario; it is not a forecast of what will happen.
Why can modern bank runs move so fast?
Concentrated uninsured deposits, mobile banking and rapid spread of information allow withdrawals at a pace that older liquidity assumptions did not anticipate.
Does GRA comment on any bank's capital adequacy?
No. It assesses no bank. Research uses aggregated data and published frameworks.
Why can a solvent bank fail?
Because if it cannot meet outflows, it may have to sell assets at a loss or close, even if its assets exceed its liabilities over time.
Are GRA scenarios regulatory stress tests?
No. They are research scenarios and set no requirement.
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