The Concept of Capital within the Framework of Basel II

The new Basel II Capital Accord has been one of the financial sector’s most fiercely discussed topics in the recent past. After many years’ debate, the regulations formally took effect on January 1, 2007, and the advanced measurement approaches are scheduled to become fully operational on January 1, 2008. The new regulations will cause a number of changes in the area of credit risk. The calculation of risk-weighted assets, and thus of regulatory capital, will henceforth be based on borrowers’ credit ratings to a much greater extent than according to the old regulations (Basel I). The concept of capital (i.e. the definition of own funds) itself will remain largely unchanged, although it was subject to repeated changes in recent decades. This paper examines the definition of capital in the new Austrian Banking Act and shows that the capital concept will need to be modified in the future. In addition, it defines regulatory capital in relation to other capital concepts, revealing inter alia that capital has a broader definition than balance sheet equity. An analysis of the capital adequacy of Austrian credit institutions demonstrates that their capital ratio clearly exceeds minimum capital requirements and that the composition of banks’ capital shows a favorably high share of core capital.