A bank is solvent when what it owns is worth more than what it owes. The gap between those two numbers is the bank’s capital, and U.S. regulators require every bank to hold enough of it to stay well clear of the line where liabilities would swallow assets. The most closely watched measure of bank solvency is the Common Equity Tier 1 capital ratio, which must be at least 4.5% of a bank’s risk-weighted assets. When capital falls below the required minimums, regulators step in with escalating restrictions, and if capital erodes far enough, the bank is closed and its deposits are transferred or paid out by the FDIC.
Solvency Is Not the Same as Liquidity
Solvency and liquidity get mixed up constantly, and the distinction matters. Solvency is a balance-sheet question: over the long run, are the bank’s assets worth more than its liabilities? Liquidity is a cash-flow question: can the bank pay everyone who wants their money today?
A bank can be perfectly solvent and still run out of cash. If most of its assets are tied up in long-term loans or bonds that can’t be sold quickly at full value, a sudden wave of withdrawals can force the bank to sell at steep discounts. Those forced sales destroy capital, and a solvent bank can tip into insolvency in a matter of days. Silicon Valley Bank’s 2023 collapse followed this pattern. The bank held large amounts of long-term securities that had lost significant value as interest rates rose, and a $40 billion deposit run forced the issue before the bank could recover.1Board of Governors of the Federal Reserve System. Material Loss Review of Silicon Valley Bank
The reverse is also possible. A bank can be sitting on plenty of cash and still be insolvent because its loan book has deteriorated so badly that total liabilities exceed total assets. Real stability requires both.
How Regulators Measure Capital
Every capital ratio is a fraction. The numerator is the bank’s regulatory capital. The denominator is usually its risk-weighted assets. Both sides need explaining.
Risk-Weighted Assets
Rather than simply adding up everything a bank owns, regulators assign each asset a weight based on how likely it is to produce losses. Safer assets get lower weights; riskier ones get higher weights. Under the Basel standardized approach used in the U.S., U.S. Treasuries and other highly rated sovereign debt carry a 0% weight. Highly rated bank and government-sponsored entity exposures get 20%. Retail loans like credit cards get 75%. Standard corporate loans get 100%. Exposures to borrowers rated below B- get 150%.2Bank for International Settlements. CRE20 – Standardised Approach: Individual Exposures
A bank holding $100 million in U.S. Treasuries and $100 million in corporate loans doesn’t have $200 million in risk-weighted assets. The Treasuries contribute zero. The corporate loans contribute $100 million. That gives the bank $100 million in RWA, and the capital it must hold is calculated against that lower figure. Banks holding safer assets need less capital; banks loading up on risky loans need more.
Capital Tiers
Regulatory capital is sorted into tiers based on how effectively each type absorbs losses.
Common Equity Tier 1 capital is the highest quality. It consists mostly of common stock and retained earnings. This is the money that takes the first hit when losses occur, and regulators watch it most closely because it’s permanent and fully available while the bank is still operating.
Tier 1 capital includes CET1 plus Additional Tier 1 instruments, such as certain preferred stock that can absorb losses on a going-concern basis. Total capital adds Tier 2 instruments like subordinated debt, which can absorb losses if the bank actually fails but offer less protection while it’s still running.
The Minimum Capital Ratios Every Bank Must Meet
Federal banking regulators, including the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency, require every U.S. bank to maintain minimum capital ratios. These translate the Basel international standards into binding U.S. law:
- 4.5% Common Equity Tier 1 capital ratio (CET1 capital divided by risk-weighted assets)
- 6% Tier 1 capital ratio (Tier 1 capital divided by risk-weighted assets)
- 8% Total capital ratio (total capital divided by risk-weighted assets)
- 4% Leverage ratio (Tier 1 capital divided by average total consolidated assets)
The first three use risk-weighted assets in the denominator. The leverage ratio uses total assets with no risk adjustments, which prevents banks from making their capital look artificially strong by gaming the RWA calculation.3eCFR. 12 CFR 217.10 – Minimum Capital Requirements
The Capital Conservation Buffer
On top of those minimums, banks must hold an additional capital conservation buffer of 2.5% of risk-weighted assets, made up entirely of CET1 capital. The buffer is meant to force banks to build extra capital during good times so they can draw it down during stress without breaching the hard minimums. A bank that dips into the buffer faces escalating restrictions on dividends, stock buybacks, and discretionary bonus payments. The deeper it dips, the more severe the restrictions become.4eCFR. 12 CFR 217.11 – Capital Conservation Buffer, Countercyclical Capital Buffer Amount, and GSIB Surcharge With the buffer factored in, a bank effectively needs a CET1 ratio of at least 7% to avoid payout restrictions.
Extra Rules for the Largest Banks
Banks with $100 billion or more in assets face a supplementary leverage ratio of at least 3%. Unlike the basic leverage ratio, the SLR includes off-balance-sheet exposures like derivatives and credit commitments in its denominator. The eight U.S. global systemically important banks face an enhanced SLR standard, and a final rule taking effect in 2026 caps the enhanced SLR requirement for their depository institution subsidiaries at 4%.5Board of Governors of the Federal Reserve System. Agencies Issue Final Rule to Modify Certain Regulatory Capital Standards
G-SIBs also carry a capital surcharge that starts at 1% and scales upward in half-percentage-point increments based on a scoring system measuring size, interconnectedness, cross-border activity, and complexity.6Federal Register. Regulatory Capital Rule (Regulation Q): Risk-Based Capital Surcharges for Global Systemically Important Bank Holding Companies Add the minimum, the conservation buffer, the countercyclical buffer (which regulators have kept at 0% since it was adopted in 2016 but which can add up to 2.5 percentage points), and the surcharge together, and a large G-SIB may need a CET1 ratio well above 10%.
Where Capital Ratios Can Mislead
Regulatory ratios are the primary solvency measure, but they have blind spots.
The biggest involves unrealized losses on securities. Under current U.S. rules, many banks can elect to exclude the effects of accumulated other comprehensive income from their regulatory capital calculations. In practice, a bank can hold bonds that have dropped significantly in market value and still report capital ratios as though those losses hadn’t happened. The losses are real economically, but invisible in the regulatory numbers. Silicon Valley Bank used this opt-out, and its reported capital ratios looked healthy right up until the deposit run forced it to sell those depreciated securities and recognize the losses all at once.1Board of Governors of the Federal Reserve System. Material Loss Review of Silicon Valley Bank
Market-based indicators can catch what the ratios miss. Credit default swap spreads, equity prices, and bond yields all carry information about how investors view a bank’s financial health, and they sometimes flag trouble well before reported capital does.
What Happens When a Bank’s Capital Falls Too Low
Banks don’t go bankrupt the way ordinary businesses do. Federal law imposes a structured escalation that begins before insolvency and accelerates as capital deteriorates.
Prompt Corrective Action
When a bank’s capital ratios slip below the required minimums, its primary regulator places it into the prompt corrective action framework, which sorts banks into five categories:
- Well capitalized: significantly exceeds all minimums. No restrictions.
- Adequately capitalized: meets all minimums. Some limits on brokered deposits.
- Undercapitalized: falls below any minimum. The bank must submit a capital restoration plan, and regulators restrict asset growth, acquisitions, and new business lines.
- Significantly undercapitalized: falls significantly below any minimum. Regulators can force management changes, restrict executive compensation, and require asset sales.
- Critically undercapitalized: the most severe category. Regulators must appoint a receiver or take other action within 90 days.
The system is designed to force early intervention. By the time a bank reaches the critically undercapitalized stage, regulators have been restricting its operations for some time.7Office of the Law Revision Counsel. 12 USC 1831o – Prompt Corrective Action
FDIC Receivership
When a bank is closed, the FDIC is appointed as receiver. For federally chartered institutions, the appropriate banking agency makes the appointment. For state-chartered banks, the state supervisor typically does, though federal regulators can also step in under certain conditions.8Office of the Law Revision Counsel. 12 USC 1821 – Insurance Funds
The most common resolution is a purchase and assumption transaction, where a healthier bank acquires the failed bank’s deposits and selected assets. For depositors this is usually seamless: accounts move to the acquiring bank, and customers often don’t need to open new accounts. When no buyer can be found, the FDIC pays depositors directly from the insurance fund.
Deposit insurance protects up to $250,000 per depositor, per ownership category, at each FDIC-insured bank. Joint accounts, retirement accounts, and trust accounts each qualify as separate ownership categories, so one person can hold well over $250,000 in insured coverage at a single bank by spreading funds across different account types.9Federal Deposit Insurance Corporation. Understanding Deposit Insurance
Shareholders and unsecured creditors absorb losses first. Equity holders are wiped out entirely in a bank failure. Bondholders recover only whatever remains after insured depositors and other priority claims are paid. That loss hierarchy is a feature of the system, not a bug: the people who profited from the bank’s risk-taking bear the cost when those risks go bad.