Why are "capital requirements" important for banks?

Capital requirements are crucial for banks because they serve as a financial buffer that enables institutions to absorb potential losses, thereby protecting depositors and maintaining overall stability in the banking system. When banks are required to hold a certain amount of capital, they are better positioned to withstand economic downturns or unexpected financial stresses. This capital acts as a safeguard, ensuring that even in adverse conditions, banks can continue to operate without jeopardizing the funds of their customers.

The ability of banks to absorb losses reinforces public confidence and trust in the financial system. If a bank were to encounter significant losses and did not have adequate capital, it could become insolvent, leading to broader implications for the economy and increasing the risk to depositors’ funds. Thus, capital requirements play a critical role in promoting financial stability and safeguarding the interests of depositors and the economy as a whole.