Capital liquidity standards are enforced (typically) by a ratio that stipulates that any given financial institution must hold a certain amount of equity (the residual claim of interest after all liabilities have been paid) in relation to any risk-weighted assets (Barrell, 2009: 4-10). Any financial risk must be offset by a certain percentage of capital. These standards have a history both in New Zealand and in the global economy. A global taskforce, the Basel Committee on Banking Supervision first codified an acceptable ratio through its voluntary Basel accords (Young, 2010: 39). These accords signed in 1988, 2004, and 2011 suggest that banks hold respectively at least 8%, 8%, and 10.5% of total capital weighed against their risk portfolios (Bank for International Settlements, 2011: 20-32).[1] This means that for every dollar lent out the lending institution must have at least 8cents of underlying assets to ensure stability. The tool of capital liquidity standards spread in popularity through this institution and others such as the Financial Stability Board in this time (Germain, 2011: 50-55). Primarily to guard against systemic risk this policy tool becomes the minimum standard of banking supervision for regulatory agencies around the world.
[1] The exact makeup of these assets is also important. From Basel I onwards the exact makeup of the underlying assets is assessed and articulated through such policy. At least half of all the assets from 2004 onwards must be considered tier 1 in nature. One may notice, therefore that what exactly constitutes capital is also important, but largely not covered in this study, for it is another issue entirely.