Bank Capital

A bank doesn’t begin solely with customer deposits. It needs money from its owners to get started. This is known as bank capital or owners’ equity.

Let’s consider a hypothetical example. A bank is launched with capital contributed by its owners. It also collects deposits from customers and may borrow money from other banks or investors. All these funds are used to create assets.

These assets include loans issued, government securities bought, and physical infrastructure built.

Now, imagine some of those assets lose value, for example, if borrowers can’t repay their loans.

The bank still owes money to depositors and lenders. But the loss is first absorbed by the owners’ capital. If the loss is small, the bank can continue operating normally. But if it’s large enough to eliminate the capital, the bank becomes insolvent — meaning it no longer has enough assets to cover its liabilities.

To prevent such incidents, the Federal Reserve monitors capital levels closely. If a bank’s capital drops too low, the Fed can block dividend payments to shareholders, restrict risky lending, or demand a plan to restore capital.