What Is Capital?

Capital is a vague term which can refer to one of two things:

  • Factories, machinery, equipment etc. owned by a company
  • The value of financial assets such as cash, short-term securities etc.

In an economic context, capital usually refers to the former whereas in banking and finance, capital is the value of the financial assets. All financial institutions have a level of capital reserve which they must meet, which usually corresponds to risk-weighted assets.

For example, if a company owns $1 billion of a AAA rated asset, and after risk-weighting this is deemed to be $200 million worth of 'risk' and the company is required to hold 8% of capital for risk-weighted assets, the company would need $16 million in capital to own this $1 billion in assets.

Problems can occur when the company has investments using leverage or invests using margin, where a small fall in asset prices can require more collateral to be posted (i.e. capital) but due to leverage the company has no spare collateral to post, and therefore has to sell off some of its assets.

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