Bank capital is often described as a cushion. That is useful, but capital is not a separate pile of cash: it is the portion of a bank’s assets funded by owners rather than creditors and depositors.
What capital represents
At its simplest, capital is the difference between a bank’s assets and its liabilities. It comes largely from money invested by owners and earnings retained by the bank.
Regulatory capital measures use more specific definitions and risk adjustments, but the central idea remains the same: capital provides loss-absorbing capacity.
How the cushion works
If loans or securities lose value, the bank’s assets decline while its obligations do not automatically fall with them. Capital absorbs that reduction before depositors and other creditors bear losses.
That is why regulators compare different forms of capital with assets and risk-weighted assets rather than looking only at the dollar amount of equity.
Capital is not liquidity
Capital helps a bank absorb losses. Liquidity helps it meet withdrawals and payment obligations when they come due. A bank needs both, but they solve different problems.
A well-capitalized institution can still face liquidity pressure if funding leaves faster than assets can be converted into usable cash.
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